Crypto investing isn’t simply about purchasing tokens and waiting for prices to rise. In recent years, decentralised finance, or DeFi, has transformed the way people use digital assets. Cryptos can no longer just sit in a wallet; they can be lent, staked or used to provide liquidity and earn passive income.
For some, DeFi is a way to earn extra income. Others have turned it into a long-term wealth-building strategy. This might sound attractive; however, the reality is that it is not “easy money”. There are risks, and it’s a lot more important to understand how these systems work.
Here’s what investors need to know before jumping in, and how people are making passive income.
DeFi passive income is earning rewards by using your crypto assets. These finance platforms are built on blockchain networks with smart contracts, which allow users to interact.
And rather than sitting on crypto, investors could:
- Stake tokens to support the operation of the blockchain
- Borrower lends and earns interest
- Liquidity provisioning for Dexs
- Participate in yield farming programs
- Users get rewarded in return, usually in crypto payouts.
The idea is simple: Earn with your crypto while you HODL. Returns are very variable and depend on market conditions, demand for tokens and the stability of the platform.
Staking is considered the simplest finance strategy for beginners. Users then lock their crypto into a network of blockchains that validate transactions and keep the network secure. And the network sends back rewards. Staking took off because it’s easy to set up and more predictable than aggressive trading strategies.
- Simple for new users to understand
- No trading activity is required.
- Simpler than yield farming
- Rewards are usually stable
Investors see staking as akin to earning interest on a savings account, but the risks are much higher.
Depending on the blockchain and tokenomics, annual returns can be low single-digit yields. However, the experienced ones tend to look at the project strength rather than the advertised APY.
Yield farming is one of the most talked-about areas in DeFi because of the high returns some protocols promise.
In this model, users deposit pairs of assets into liquidity pools that power decentralised exchanges. In return, they also receive a cut of the transaction fees and other token rewards. This is where all those crazy APY numbers you see tossed around in crypto-land tend to come from.
Why investors like yield farming
- High return potential
- reward parallel streams
- Exposure to New DeFi projects
- Opportunity to make use of under-utilised assets
But it’s also very risky to do yield farming. Projects with very high rewards can lose their value when the token price crashes, and liquidity disappears. Many novice investors don’t learn this until they chase unsustainable yields.
And impermanent loss is another problem often overlooked. The token price fluctuations can lead to a decreased profit and even a loss, even though the rewards are still flowing in. Yield farming remains a good way to make money, but the successful users tend to be more cautious with risk management.
Not everyone wants to be looking at liquidity pools all day or managing complex farming strategies. Crypto lending is easier for many investors to understand. In DeFi lending, users deposit assets into a lending protocol. When collateral is provided, the lender receives interest, and the borrower receives a loan. Stablecoins are popular for lending because they reduce exposure to market volatility.
- Standard financial model
- Passive and quite straightforward
- Stablecoin at low volatility
- Earnings on your own terms
But loan protocols have their dangers. Exploits of platforms have led to the loss of large sums of money in the past. Even big platforms can run into unexpected problems in times of market stress. “Safe” is never synonymous with “passive.”
The biggest mistake in DeFi is chasing APY without understanding risk
Many investors move money to unknown platforms because the advertised returns look attractive. Indeed, in practice, very high yields are often not sustainable and can disappear overnight. The other mentality experienced by users usually has:
- Research the protocol first,
- Know from where the rewards come
- Don’t buy into the hype
- Spread the money, don’t concentrate it
- Aggressive returns are less important than security
For most purposes, it is more important to keep capital intact than to maximise short-term profit. The winners are not always the sexy platforms at the peak of the hype cycles in the market.
DeFi has created all-new ways for crypto holders to make money with their assets. There are ways to make money without having to trade on a daily basis, and these include staking, lending and yield farming.
But finance is still a high-risk environment, with smart-contract vulnerabilities and market crashes. DeFi can be a useful tool for investors who are willing to learn the ins and outs of the ecosystem to grow their portfolios over the long term. But the best performers are those who concentrate on sustainability, risk control and patience.
In general, yield farming is considered more risky than lending and staking with stablecoins. But there’s no such thing as a totally risk-free DeFi play.
Yeah. Staking is often a starting point for many beginners as it is easier to understand and requires less active management than more advanced strategies like yield farming.
Returns are dependent on platform, token and market. Some protocols offer small single-digit yields, while others have much higher APYs, usually associated with higher risk.
Impermanent loss occurs when the value of tokens in a liquidity pool diverges from the value of simply holding the tokens. This could eat into the profits of liquidity providers.
No, DeFi earnings are not guaranteed. Returns are subject to market volatility, smart contract exploits and platform failures, which could lead to losses.
High APYs are a common way to quickly lure liquidity. Such rewards are often not sustainable and can drop sharply once demand from users falls.
