Passive income is often understood as a way to make money with little or no effort, where existing assets generate new assets. Even though passive income has been popular for many years, DeFi gives us new strategies to make money on crypto.
Cryptocurrency has long been a popular investment for many people around the world. However, the use of blockchain technology until recently was still quite limited. Blockchain assets could only be traded or stored, but much has changed recently.
The advent of DeFi has been a groundbreaking event as it has revealed new uses for cryptocurrencies and opened up investment options. Thus, simply by storing assets in their wallet, people can make a profit. Moreover, with the help of DeFi, people can also use several strategies at once to earn passive income. As the world of Decentralized Finance is constantly growing and evolving, there are more and more opportunities for profit.
Despite some risks that, by the way, are present in any investment, passive income can open entirely new prospects for you to use your crypto assets. Today we will focus on the main DeFi strategies, from staking to yield farming, to help you make a profit in 2023.
What Is DeFi?
DeFi (or Decentralized Finance) is a term that is used in the crypto world to describe decentralized applications, the distinguishing feature of which is the provision of financial services on the blockchain. In simple terms, people who do not want to let the government interfere with their finances use such applications for various kinds of financial transactions. Thus, DeFi can be called an alternative financial system free from centralization. DeFi runs on a decentralized network of computers, thus eliminating any central authority or traditional intermediaries to complete services.
Banks, credit unions, or the government run the traditional financial system, while DeFi supports transactions performed on the blockchain. Thus, people can make payments and transfers and take loans with smart contracts. Decentralized finance has gained recognition for being much more transparent, secure, and cheaper for all its users.
Main Pros Of DeFi
- The absence of intermediaries. Unlike a traditional financial system, DeFi is not controlled by anyone, so it does not need intermediaries.
- Availability. To obtain a loan from a centralized institution, you must meet the eligibility criteria, have a good credit score, and provide personal data. With DeFi, anyone on the network can receive money.
- Safety. The use of smart contracts and the absence of third parties make financial services as safe as possible and eliminate the risk of human error.
- Speed. With DeFi, unlike banks, users do not have to wait for a transaction or loan to be approved, as everything happens automatically.
- Small fees. Banks and credit unions charge many fees, so DeFi is also a cheaper alternative.
- Transparency. Since all DeFi transactions are visible on the blockchain, users always know what is happening with their money.
Thus, while the traditional financial system has been around and has been running successfully for many years, DeFi challenges it in terms of fast and cheap transactions and generating passive income.
How to Make Money on DeFi? Best DeFi Passive Income Strategies in 2023
Lending is the first thing that comes to mind regarding DeFi's passive income strategy. For many years, lending has been an essential part of the economy and remains popular today. DeFi has dramatically improved the existing system, as unlike traditional lending, DeFi lending does not need bank or government approval.
The process is as simple as possible: deposit funds into smart contracts, and other borrowers use them. This way, you earn interest for lending them your cryptocurrency on platforms (like Venus or Aave). As a rule, smart contracts are distributed proportionately to the number of assets you lend and block. "Due to the over-collateralized nature of DeFi lending protocols, these loans are typically safer and have less risk of creditor default." - Nansen.
If you want to use the simplest DeFi strategy for obtaining passive income, then lending is exactly what you need. However, before becoming an investor, consider the credit utilization rate. If you have previously dealt with traditional borrowing, you have probably heard this term. So, if you want to get the most return on your investment, you should look for options with high utilization rates and low total supply. But remember that the more income you receive, the greater the risk.
To sum up, lending is the easiest way to earn passive income with DeFi; however, not all assets can be used for lending, and modest interest rates lead to certain risks.
"Staking" can be explained as locking your cryptocurrencies with a PoS (proof of stake) blockchain platform to help validate transaction blocks. Thus, since you deposit your funds, you will receive passive rewards for doing so. This DeFi strategy is one of the most popular for making crypto money since you generate passive income and help make the network safe from spam and threats.
The main advantage of staking that new investors like is that you only need one asset to earn passive income. Thus, if you have already purchased cryptocurrencies in which you are confident and plan to hold them for a while, staking is a great option. Also, before you start staking, you should pay attention to the difference between validations and delegators. Validations are required to have more capital and technical deficiency to run nodes, while delegators just delegate their stake to a validator node.
So, staking is a passive income strategy that allows users to earn rewards for staking their funds, which are used to verify transactions. Moreover, investors can receive not only the platforms' native cryptocurrency but also a portion of platform fees. Staking gives you the right not only to make money with DeFi but also to secure the network. If you're looking for staking platforms to get you started, check out Nansen Lido Dashboard, Nansen Opportunities, and Lido.fi.
Providing Liquidity and Mining
Another opportunity to make money with DeFi is to become a liquidity provider (LP). While staking helps secure the network, liquidity providers provide a faster and more efficient exchange of tokens on decentralized exchanges. "Investors contribute liquidity to liquidity pools on decentralized exchanges facilitating permissionless swaps." - Nansen. For providing liquidity, you will also receive a reward, namely a percentage of trading fees. After receiving the token, you can reinvest it in other platforms, which will receive even more rewards.
Although users receive a portion of the transaction fees per trade, there is no need to participate in the process. The advantage of decentralized exchanges like Uniswap or PancakeSwap is that they use AMM algorithms to automate processes, namely filling orders and trading services. Accordingly, the more liquidity in the pool, the better, which is why various exchanges reward liquidity providers.
As with other DeFi trading strategies, liquidity comes with risks. Depending on the pair used to create the LP token, the risk can be minimal or maximal, where the highest risk leads to the highest reward. However, if you do your research and compare options, you can invest in assets held in highly liquid pools with safe crypto assets.
The term yield farming is quite broad and refers to DeFi strategies for generating passive income using cryptocurrencies. In simple terms, you can increase your investment by pausing it in exchange for a reward. It works like this: using DeFi platforms, you place your funds in a liquidity pool after smart contracts in dApps lock serotonin. Thus, you will receive a fee or interest for allowing your assets to be used on the platform.
Most likely, you have already noticed the similarity with the banking system, where people deposit into their account and allow their money to be used for various transactions, after which they receive a fixed percentage of interest. Thus, yield farming is an interest-bearing deposit in the DeFi world. People who use this strategy are called yield farmers.
It is important to note that although this type of passive income is popular, it may require more involvement and knowledge than the previous strategy. Since there are many DeFi protocols and pools, this requires quite active management of funds. Farmers often switch between liquidity pools to get the maximum profit, as the yield may vary depending on the number of participants. Other than that, be sure to research and only choose reliable platforms like BeefyFinance, or you risk losing your investment.
DeFi is an innovative alternative to centralized financial systems that allow investors to collect fees instead of using banks as third parties. In addition, DeFi has provided users around the world with many passive income strategies. Although each comes with certain risks, you can still earn rewards without actively participating after doing your research. What's more, if you don't use the crypto assets you hold, strategies like staking or lending are great options for you. If you are a more advanced investor who wants to delve deeper into DeFi and get the most profit from your assets, yield farming will give you that opportunity. Compare options, study the strategy, and choose the one that suits you best.
Disclaimer: Notum does not provide any investment, tax, legal, or accounting advice. This article is written for informational purposes only. Cryptocurrency is subject to market risk. Please do your own research and trade with caution.