The recent hype and advancement in the Decentralized Finance (DeFi) space has seen many blockchain-based applications pop up. In the crypto borrowing and lending space, there are also several centralised finance (CeFi) platforms such as Nexo, Celsius, Coinbase, OKEx, Luno, Binance, Kucoin, just to name a few – where people can also earn interest on their digital currency holdings.
As financial technology advances, we can expect to see more decentralized applications being adopted for various use cases. Currently, DeFi apps can be seen as as non-custodial banks that allow users to control their funds without regulations. Listed below, we can find samples of the most commonly used ones:
If you take a deep dive into how decentralized finance works, you will understand what a stablecoin is and the function it performs. A stablecoin is a digital currency with a unique monetary value, like the fiat currencies we use daily. Since the worth of these stablecoins is reliant on fixed assets, they tend to be operated more centrally than most cryptocurrencies. A finance company holds up local currencies and then issues out coins with values equivalent to that of the currencies reserved.
Another method to earn money from stablecoins is their lending scheme, where interests are paid on any amount invested. Some of the popularly used stablecoins are;
- Dai (DAI): This coin is formed when you open a Collateralized Debt Position (CDP) on MakerDAO by reserving Ether.
- USD Coin (USDC): USDC is issued by regulated financial institutions, and backed by fully reserved assets, and redeemable on a 1:1 basis for US dollars. USDC is governed by Centre, a membership-based consortium that sets technical, policy and financial standards for stablecoins.
- TrueUSD(TUSD): TrustToken issues its unique coins, and depositing money into your TrustToken accounts automatically converts it to TUSD.
Stablecoins are not limited to the above, there are a lot more available across different digital asset markets.
How do I make money from lending?
After you have done your research and decided which stablecoin you are interested in, you will need to complete the following to get started.
It is essential to have a wallet to keep all your digital currencies and link them with the DeFi dApp. To get a coherent experience, it is advisable to use a very popular and trusted wallet. Download Google Chrome’s MetaMask extension from the web browser to your PC. This will ensure all your tools are managed in one place with ease of access to your Ethereum wallet with private keys.
After downloading the Metamask extension, you should get your public Ethereum address. This public address is only accessible when you have your private keys. The public address is a user ID by which can be identified why the private key is your unique password, which cannot be disclosed, unlike the user ID. Send your holdings there.
Then choose your desired DeFi platform; the ones with the highest interest rates are more advisable.
- After picking your desired platform, you’ll need to link Metamask to the app.
- You will then need to approve the DeFi smart contract so it can operate fully.
- It would be best to consider that transaction fees apply to every smart contract interaction with Ethereum, which may seem expensive. Still, with time this should be minimized in time for when Ethereum 2.0 is released.
How to use DeFi case study
You, too, can earn significantly through putting your idle cryptocurrencies to use. When you earn interest on a daily or weekly basis, we say, you are earning a passive income.
People lend out their cryptocurrencies through a process called yield farming. When they invest their cryptocurrencies they earn fixed or variable interest plus other incentives.
Yield farming is when you invest capital in order to earn interest. Similarly, you can also earn interest from investing cryptocurrencies in selected platforms. An individual can invest through liquidity provision or lending, for which he/she earns a fixed or variable interest, depending on the platform used.
For ease of understanding, take yield farming to mean lending out cryptocurrencies in order to earn interest. Examples of popular sites where people earn through yield farming are Aave and Compound. Therefore, we will use them in our illustrations.
Before going further, let’s look at the best cryptocurrencies you can invest and earn passively from. It is best to deal with stable coins, which are cryptocurrencies whose value are pegged in United States dollars or valuable assets such as precious minerals. The stable coin pegged to the United States dollar is at par with the US dollar, meaning it trades at a rate of 1.1 with the dollar.
Examples of stable coins are DAI, USDC, TrueUSD (TUSD), USDN, Binance USD, USDC and USDT. Therefore, when you want to earn passively, you can convert your cryptocurrencies or fiat currency to any stable coins. As a fact, you can buy stable coins at NOVA exchange, CCEX and cryptsysettlement.com or any other exchanges.
Earning from lending
You do several activities to earn from lending cryptocurrencies.
STEP 1: Buy stable coins and put them in your wallet. You need to connect your wallet to a DeFi application such as Metamask, which you can install easily on your chrome browser. It enables your wallet to interact with the blockchain.
STEP 2: Transfer your coins to your public address. You protect your wallet using a private key, which acts as your password.
STEP 4: Supply the stablecoin you want to lend such as ETH, DAI or USDC. Once you do that, you will see the various interest rates.
Then you select the stable coin with the best return. To enable lending, click on “SUPPLY.”
Providing liquidity is another way of earning passive income. The individual deposits the required amount of a specific cryptocurrencies such as such as ETH and DAI. With liquidity provision, people invest in paired cryptocurrencies called pools. Examples of pairs are mUSD/USDC, mUSD/WETH or mUSD/MTA.
As a result, you will earn interest generated from the trading fees of the pair you invested in. In addition, a platform like Compound gives you other rewards in form of its internal token called COMP.
We discussed the process of connecting your wallet to Aave and Compound under lending. Therefore, the procedures for connecting the wallet and depositing the cryptocurrencies work in the way explained previously.
Staking cryptocurrency is the third way of earning passive income. With staking, you simply deposit your idle cryptocurrencies and command “STAKING.” Here you only use a single cryptocurrency, there is no pairing.
When the cryptocurrency is in your wallet, you simply click “STAKING.”
After that, you confirm the transaction.
Challenges you may face
While DeFi seems promising enough to resolve all the redundancy in the traditional financial system, it is not free from challenges. It is therefore advisable, to understand how different platforms operate before committing a lot of funds. When you provide liquidity, stake or lend cryptocurrencies at times you encounter problems. The few problems that may arise include:
1. Bugs and Vulnerabilities: The vulnerability of the DeFi market to bugs and cyber attacks is brought about by its high rise in value, which is mostly being managed by third-party security firms. These firms provide a sense of security, and as such, no reports of hacks have come out.
2. Interest Rate Fluctuations: The range in the interest offered by DeFi firms for smart contracts is quite high and volatile, with no assurances of a stable rate for long. Always be in the know regarding the rates offered to stay ahead and not lose much.
3. Liquidation Risks: Assets with low liquidity used in a debt-collateral system could potentially see their values decrease massively. The Ethereum network isn’t quite favorable for numerous operations simultaneously, which may bring about pending loans not being paid out by the sale of the asset.
4. Stablecoin Hiccups: Problems arising from the association of Stablecoin to its banking partner Tether, which is currently having issues, has led the value of 1 USDT to drop in the price range of $0.90. While it is a good alternative to many digital currencies in the market due to its stability, these factors may or may not make it the best option in the long run.
Many people earn passively through yield farming and lending. Although you may face challenges such as cyber-attacks and bugs, they are not very common. After all, most crypto organisations use high security measures to overcome such challenges. Nonetheless, the DeFi ecosystem is still a work in progress. While there are so many investment opportunities available, there are still clouds of doubt hanging over. Constantly checking through related news updates and market happenings will help reduce the associated risks. It is best not to throw caution to the wind to be effective at risk management.