Let's start by addressing the fundamental question of "what is decentralised finance?"
Decentralized finance (DeFi) refers to a wide range of financial applications that make use of cryptocurrencies and blockchain technology. By eliminating middlemen from financial transactions, DeFi is expected to challenge established financial intermediaries.
Human middlemen, often known as gatekeepers, have long been a hindrance to financial transactions. The traditional financial system, on the other hand, is disjointed and inefficient. DeFi enables value transfer between a variety of complicated financial instruments.
This occurs, crucially, even in the absence of centralised entities like historical banks, and hence without the control of a single organisation or party. As a result, DeFi subscribers have more power and financial independence as a result of this. Open finance is a buzzword that has come to represent many of the elements under DeFi.
One of the most common applications of DeFi is lending, but there are many other possibilities too: decentralised exchanges (DEXs), staking, derivatives, crowdfunding, and insurance. DeFi makes all of these services available without the use of third-party middlemen.
DeFi apps, on the other hand, are highly automated and rely heavily on smart contracts. Smart contracts can be used to execute trades, token exchanges, and many other services.
Ethereum's Decentralized Finance
In the majority of DeFi applications, the Ethereum blockchain, the second-largest cryptocurrency network, is employed. Despite this, several other blockchains are gaining traction and may be able to compete with Ethereum's DeFi offers. Cardano, EOS, and Polkadot, in particular, are platforms that are pushing DeFi both outside of Ethereum and, in some ways, within Ethereum.
The majority of DeFi, on the other hand, has been created on Ethereum for a variety of reasons. Ethereum is a platform built on the concept of programmable money. Unlike Bitcoin, which has been dubbed "digital gold," Ethereum offers a technological solution to the uneasiness felt in existing financial systems. At a time when the global financial infrastructure is in upheaval, DeFi is altering the global economic landscape by offering permissionless, borderless, open money to the masses.
The impact of the COVID-19 coronavirus epidemic has added to the attractiveness of DeFi. Interest rates are flirting with negative returns on a global scale. Furthermore, massive stimulus packages are depreciating practically every major fiat currency's basic fundamentals. DeFi gives a lifeline to those who may have previously been denied access to some financial services by making the same financial instruments available to everyone.
Why is DeFi so well-liked?
DeFi has established tools for financial independence all across the world. DeFi can be an effective method for protecting wealth while avoiding capital controls. DeFi services also enable quick and cost-effective remittances outside of the regular financial system, without the need for KYC.
This is especially important for people who do not have access to fundamental financial services, whether owing to a lack of official documentation, legal status, or the lack of such services locally. DeFi makes no distinctions. DeFi promotes financial inclusion by allowing anybody, regardless of money, status, religion, or location, to access financial instruments.
The spread of stablecoins is another factor that contributes to DeFi's popularity. Stablecoins are blockchain-based, price-pegged assets that may be freely traded with other cryptocurrencies.
Stablecoins have a number of drawbacks, one of which is that they are not always trustworthy. Algorithms are used by several stablecoins to keep the price as close to $1 as feasible. These valuations, however, can fluctuate and, on rare occasions, depart significantly from their baseline.
Even though this happens infrequently, it can pose major issues for liquidity providers and yield farmers that rely on stablecoin to stay stable. However, thanks to DeFi, a myriad of other stablecoins are now available. To mitigate the risk of such an incident, several DeFi protocols can diversify by constructing baskets of multiple different stablecoins.
Stablecoins also provide the foundation for other fintech and traditional banking organisations to enter the crypto market.DeFi also lowers the entrance barrier to engaging in derivatives and synthetic markets. DeFi platforms like Synthetix allow users to have exposure to a number of markets without the use of a broker or other type of middleman.
Everyone should use DeFi.
DeFi also allows customers to participate with significantly lower initial investments than many traditional providers. A person who wants to invest in gold or stocks could do so without needing a vault or brokerage account.
Many traditional traders have been interested in DeFi. Traditional markets are devoid of high yields and volatility. DeFi, on the other hand, caters to a wide range of risk appetites. In most marketplaces, trading cryptocurrencies is one of the highest-risk investing alternatives. Trading altcoins, on the other hand, can be one of the most rewarding kinds of trading if risk is properly managed. This, unsurprisingly, is attracting the interest of traders from all walks of life. Wrapping services like renBTC or Wrapped Bitcoin are probably one of the most appealing aspects of DeFi (WBTC).
These services allow Bitcoin hodlers to store their funds on the Ethereum blockchain and create ERC-20 tokens tied to the Bitcoin price. This has resulted in an influx of new DeFi users. Many Bitcoin maximalists have changed their opinions about Ethereum's value proposition because of the wrapping services. They also help the DeFi industry by using up extra Bitcoin that would otherwise go to waste.
Because of DeFi, prediction markets have become very popular in the crypto world. The blockchain has allowed for the creation of new markets that would not have been conceivable otherwise, as well as the introduction of the notion of prediction markets to a new audience. You can wager on elections, sports, the weather, and just about anything with DeFi!
Although DeFi has a lot of intriguing applications, it also has a lot of risks. Learning how to earn a passive income with DeFi is one of the safest methods to discover the various benefits of this ever-evolving ecosystem.
How Can DeFi Help You Earn A Passive Income?
Becoming a Liquidity Provider is one of the simplest methods to learn how to earn a passive income with DeFi (LP). Users can swap ERC-20 tokens directly from a web3 wallet to practically any other ERC-20 token on Uniswap, a decentralised exchange. The main distinction between DEXs like Uniswap and controlled exchanges (CEXs) like Coinbase and Binance is that liquidity providers make the tokens available.
Fees are paid to the exchange when trading on CEXs. However, fees are paid to liquidity providers by DEXs like Uniswap (LPs). LPs just deposit an equal USD amount of two tokens to a liquidity pool, called a pair. LPs get a share of the fees that are made when people buy and sell tokens.
Providing liquidity to a platform like Uniswap is one of the simplest methods to discover how to create a passive income with DeFi for anyone who has idle assets and is wondering how to put them to work.
The Maker is regarded as one of the DeFi's original fathers. The Maker, widely regarded as the first building block on top of Ethereum, was a crucial motivator for the rise of DeFi adoption. MakerDAO is a decentralised autonomous organisation that uses the MKR token to run the Maker platform. With the two Maker tokens that were made, MKR and DAI, token holders can vote on protocol and event changes.
ERC-20 tokens are used for both the governance token MKR and the stablecoin DAI. DAI is one of the most commonly used stablecoins among individuals who know how to generate money with DeFi. Unlike stablecoins like USDT or USDC, which rely on a centralised financial entity to back their value, Maker takes a decentralised approach to their stablecoin. Holders are motivated to keep the DAI token linked to a $1 price by burning the MKR token in response to price changes.
The Maker platform provides borrowing and lending services through collateralized debt positions, which are smart contracts (CDP). Users can deposit ETH into the Maker CDP smart contracts to receive over-collateralized loans worth up to 66% of the collateral value.The most widely used decentralised stablecoin in the DeFi ecosystem is DAI. Soon, you will learn how to make money with DeFi by using the DAI stablecoin in other DeFi applications on the Maker platform and making money from that.
Compound Finance is a decentralised, algorithmically controlled platform for cryptocurrency lending and borrowing. A simple interface and a picture of the best interest rates for lending and borrowing make the Compound app easy to use.
Users of Compound can borrow against their crypto assets or offer liquidity to the protocol. Supply and demand determine interest rates for lending and borrowing. Compound has no lock-up period, so you can add or remove liquidity from pools at any time.
The goal is to earn interest that may be compounded by supplying liquidity, as the name suggests. The COMP governance token is also earned by protocol users. The COMP token was the catalyst for DeFi's summer. Users began to appreciate the full potential of DeFi when the price of COMP grew drastically. Compound was essential in the emergence of yield farming, a practise in which knowledgeable liquidity providers jump from platform to platform in quest of the best potential payouts.
The compound has previously been formally checked and audited. The compound has been governed by the community since May 2020. All modifications to compound are debated, proposed, and voted on by holders of the COMP token and their delegates.
The peer-to-peer lending network changed to Aave in January 2020 after being known as ETHlend since its debut in November 2017. (Fun fact: Aave means "ghost" in Finnish.) Because of its simplicity and clean UI, Aave is one of the most popular DeFi platforms. In addition, Aave accepts a wide range of assets and cryptocurrencies as collateral for loans. The ability to remove collateral at any moment, with no necessary lock-up period, is a plus for users.
The protocol has a bug bounty programme in which developers are rewarded for discovering any bugs or flaws in the infrastructure of Aave. Aave's smart contracts have also been subjected to intensive auditing. When flash loans were added, users felt safe because of these security procedures and policies.
Uncollateralized loans that conduct all borrowing, lending, and repayment in the same transaction are known as flash loans. Flash loans could be a very dangerous approach for those new to the crypto business to learn how to generate a passive income with DeFi. Before using a protocol, do your own study and make sure you grasp the concept.
On the Ethereum blockchain, the Balancer protocol was introduced in March 2020. A balancer is an automated market maker (AMM) that pays liquidity providers fees. Balancer is a second-layer platform developed on top of Uniswap that allows AMMs to integrate many assets into a single liquidity pool, even if their weights are uneven.
AMMs make market-making easier by eliminating the need for middlemen. Rather, the rules of any trades conducted on the site are determined by algorithms.
The Balancer can be thought of as a self-balancing cryptocurrency ETF. Users can either start and run their own crypto index fund or contribute liquidity to an existing pool. These pools are self-contained and self-balancing. This means that tokens can be freely traded without removing them from the pool.
The Constant Mean Market Maker is one of the balancer's core functions (CMMM). In a liquidity pool, up to eight different tokens can be added and swapped or taken out without any hassles.
Andre Cronje developed Yearn Finance entirely on his own. Yearn.finance is a yield aggregator and DeFi ecosystem that helps consumers get the most out of their money. Yearn.finance optimises token lending and delivers consumers the maximum annual percentage yield (APY) available based on their risk tolerance by utilising various DeFi protocols such as Curve, Aave, and Compound. This is accomplished by discovering the best token lending yields across many platforms. All of this takes place behind the scenes, saving users a significant amount of time and effort.
The yPool on Curve Finance is one of Yearn.finance's several lending and farming opportunities. The yPool converts user deposits into "yield optimised tokens" (yTokens), such as yUSDC, yUSDT, and yDAI. This feature allows users to earn both loan and trading fees from Yearn and Curve. This is because money is sent through yEarn to different parts of the DeFi industry.
Yearn has since offered some of the most amazing 2020 rates. Many consider the platform to be one of the most innovative DeFi platforms on the market, and it is responsible for some of the highest yield advances made by farmers. Yearn is also regarded as the most decentralised DeFi platform.
Furthermore, demand for the platform's native cryptocurrency is high due to its limited total quantity of 30,000 YFI tokens. In fact, the YFI token hit a high of $43,000 in September and has continued to rise since then. YFI is now trading at $28,465 and has come a long way since its low in early November.
Summary of How to Earn a Passive Income With DeFi
Although decentralised finance is a terrific way to supplement your income, there are several concerns to be aware of. Yield farming protocols are sometimes known as "strange DeFi platforms." Surprisingly, food meme coins like Yam, Pasta, and Sushi can occasionally provide significant rewards. However, they are almost always a one-way ticket to wrecked City. Because these protocols necessitate such close attention to price movement, you could consider this an active rather than a passive source of revenue. They are also usually short-lived, so only those who can get in early and avoid the post-launch crash will benefit.