ZoneBitcoin EditorialLast time, we saw in the first part of the DeFi mini-training how to smoothly “enter” DeFi. We saw how to open a decentralized wallet, how to send tokens and how to add networks.
But now is where it's going to get interesting. Now we will see why it is interesting to enter DeFi.
And no surprise, dear readers, if so many people want to be part of the game, it's because there are money to be won. A lot. It is therefore without great surprise what we will see and understand in this second part of the DeFi training.
Disclaimer: We will see the methods here to make money on DeFi, we are preparing videos more about passive income in a future video. There, what matters to us is not so much to give you the fish to eat as to give you the fishing rod and to understand how we fish... You understand where we were going with this, don't you? not? Train you and help you better understand what happens when we talk to you about making money on DeFi.
Make money on DeFi
Of course, one may want to use DeFi for different reasons, but very clearly, what attracts the most is the possibility of getting financially rich.
Decentralized finance creates new “professions” just like traditional finance creates traders. Today, traders have changed hats, and they operate other equally lucrative activities. However, this requires certain knowledge and unfailing patience because the volatility of cryptos is no longer in doubt.
There are whole new skills and activities that have been created in DeFi. Users around the world are increasingly using decentralized services with annual yields (APY) that put those of traditional banks to shame.
What makes this world even more interesting (beyond earning money) is certainly the incredible flexibility and ease of use of these services. Anyone can access it without giving any personal information. Borderless banking is open to everyone, regardless of budget, everyone can find something to their advantage.
New ways of earning money have emerged, and today, it is the new gold rush that is shaking up our times.
The 4 methods to make money on DeFi
Method 1: Lending and borrowing
It is certainly the best-known DeFi activity and also the oldest. Moreover, the first DeFi platforms initially mainly offered this type of service: lending and borrowing cryptos.
We can think, for example, of the pioneers in this field that are Coumound Finance and MakerDAO. This is a relatively simple protocol to understand. There are two types of users on these platforms: the lender and the borrower.
You can think about the lending and borrowing system on your bank. It is indeed the same system even if the underlying mechanism is different. There, it is a smart contract which will take care of loans and borrowings. There is no intermediary as is the case with your bank. There, on DeFi, smart contracts directly connect the money deposited by lenders with the amount withdrawn from borrowers. It is this absence of an intermediary that allows DeFi to offer much higher interests than those found in traditional finance. No need for a banker, premises, papers, manual contracts etc. Everything is done automatically and in just a few clicks with no barrier to entry. Anyone can lend or borrow if they have a decentralized wallet.
Anyone who lends their assets to a platform will lock them in a smart contract. Borrowers, on the other hand, can then access the deposited assets as a loan. They will reimburse the interest on the loan to the platform. It is therefore the platform's smart contract which will distribute interest to lenders in proportion to the amount they have deposited.
Also, what is great about these platforms is not only the automatic management of loan and borrowing contracts. It is above all the fact that the guarantees are much more solid than in traditional finance.
Let's take a simple example. If you borrow money from your bank to buy real estate, the bank will ask you for a contribution (10% for example) of the total amount you are going to borrow. As a guarantee, the bank (if you are unable to pay your loan) will seize the property. This is his guarantee to lend you money.
On the Defi, the approach is different. However, a guarantee is essential if we want to ensure the proper functioning of the process as a whole. In the Challenge too, we want to limit payment defaults. Instead of asking you for a guarantee on future property, you are asked for an immediate guarantee. For example, if you want to borrow 1000 euros on Defi, you will be asked to deposit the equivalent (and even more) in crypto to borrow.
Borrowers use DeFi loans because if the price of cryptos rises, they get back their deposited amounts (less interest paid) without having to sell.
Concrete example (we take round numbers and refined situations to make understanding the calculation simpler).
- Jacques at 1 ETH which is worth €1000 at a given time.
- He wants to borrow €800 on DeFi with a rate of 4% and a TVL
- He will deposit his €1000 in ETH and receive his €800 in stablecoin which he will repay in 6 months. He will have to repay everything
- The price of ETH has climbed and 6 months later, and he will then have obtained his loan (to make other lucrative purchases certainly?) and above all he recovers his ETH which today is worth €3000
This is a typical example of why borrowers use DeFi. At first glance, this may not be easy to understand for a beginner.
In fact, being a DeFi borrower can be extremely profitable for a seasoned user. You have to know how to use your loan wisely and it makes little sense to do so if you simply want to borrow (and not put your loan to work).
The people who make money with this method are the people who are lenders. It's simpler on the one hand because we don't need to make other speculations.
We only receive the interest on our loan. Depending on the platform, the crypto, the interest rates vary.
Interest rates vary daily. Double-check each platform before committing.
To take advantage of this type of service and do it with ease on Ceci sites, you have sites like Youhodler:
Method 2: staking
It is certainly the activity on DeFi which is the most popular and which is also the simplest. There, the users will deposit a certain amount of a given token into a smart contact. To take a look at traditional banking, it's like having a Livret A account, except that the interest here far exceeds the usual rates announced by the banks.
Your deposit will generate additional income on its own, usually from the same token you deposited.
For the underlying mechanism, it is actually an incentive created by the developers to keep the blockchain functioning properly. Staking is made possible by the implementation of a “Proof-of-Stake” type consensus mechanism (i.e. proof of stake).
There are different types of consensus mechanism of a blockchain. It is on it that the mode of operation and remuneration of a blockchain is based. We call this a “consensus” in the sense that all operators agree to operate in the same way. The two best-known consensus mechanisms are the proof-of-work and proof-of-work algorithms.
So, to give you a brief reminder, a blockchain, due to its decentralized operation, is made up of several computers which “run” the network. We often have the image of bitcoin miners who are rewarded for their work with bitcoins. Well, for blockchains that have a Proof-of-Work consensus mechanism, payments are made to those who “stack” tokens. This is how the network can operate and how there are sufficient incentives to validate and secure the operations that took place on the blockchain in question. If you are wondering where this money comes from, remember that it is often the transaction fees that are actually paid back to those who stack.
In general, the more the amount deposited and the longer the locking time, the greater the reward.
Given the excesses of Proof of Work type consensus mechanisms, many Blockchains are turning to Proof of Stake. There are therefore plenty of choices when it comes to staking.
Even DEXs or protocols offer this option like Uniswap or even PancakeSwap. Exchange platforms like Binance or Kucoin also offer starking options for certain cryptocurrencies.
The hardest part of staking is actually choosing the right platform and the right token! We can very well decide to stack on a token which does not have great longevity although it has an attractive rate.
That said, when you choose a good crypto, it remains a royal way to earn cryptocurrencies.
Existing platforms like Feel-mining which are registered under the AMF can be very useful if you want to do staking in a simple way.
Method #3: Become a Liquidity Provider
There, we begin to enter into the most difficult methods. These are the methods that can bring in the most, but which also prove to be the most “risky”. Becoming a liquidity provider is also called Liquidity Mining.
These are the DEXs like Uniswap and especially Sushi Swap who popularized this activity on DeFi. Decentralized exchange platforms are the equivalent of CeFi trading platforms. These are what we call automated market maker protocols (the famous AMM) or market maker.
We are not going to go into details here, but there are other forms of DEX operating on different AMMs. Each AMM follows its own equations and algorithms. We will talk about it again in a dedicated article.
There is no order book but liquidity pools instead. Liquidity pools are made up of token pairs (with the same value). So, in a liquidity pool of €1000 of ETH/USDT for example, we will find €500 of ETH and €500 of USDT. It is thanks to these pools that users can exchange tokens with each other, without the need for an intermediary.
So, here again, we had to find incentives so that people would want to deposit cash. We then again receive a percentage of the commission fees made on the DEX. When you trade on a decentralized platform, you also pay fees. These fees are then redistributed in proportion to the deposit made in the pool.
For example, Uniswap charges a 0,3% fee on all swaps made. Thus, liquidity providers receive a portion of the fees based on their shares in the pool.
Naturally, the more trades there are on the pool, the more money LPs make.
So, when you become a liquidity provider, you automatically receive liquidity provider tokens (LP tokens). We receive it in proportion to our contribution to the total pool. Thus, the LP tokens that we receive are the “proof” that we have deposited in the pool. To recover our stake, we return our LP tokens.
We were talking to you about the risks of becoming a liquidity provider which are due to the volatility of token prices. The best known risk is what is called “Impermanent loss”. To quickly summarize it, tell yourself that this happens when the pair becomes completely unbalanced and no longer corresponds to the market price.
In fact, the more the price difference of the token when depositing is different from that displayed on the markets, the more one is exposed to non-permanent losses. In fact, basically, tell yourself that by making your withdrawal, you will not necessarily withdraw what you deposited. You will withdraw the percentage you deposited. So, if the pair varies too much, you can end up “losing” and not to mention the network fees for withdrawing and depositing your funds.
Also note that non-permanent losses occur regardless of whether the asset decreases or increases. It is the price difference between the price of the deposit and that of the withdrawal which produces the permanent loss.
Here is the table of permanent losses according to price variations in the Binance article:
Sometimes, you will be more profitable by holding your cryptos.
Want a concrete example? Here again I take very round figures and ideal situations for the calculation:
- Jean Pierre deposits 1 ETH and 100 USDT for a total of $200 at hour x.
- He deposits into a pool that contains 10 ETH and 1000 USDT and then owns 10% of this pool of $10,000.
- Days pass and the price of ETH rises to 400 USDT. Traders who arbitrage add USDT to the pool and withdraw ETH (they put in less) until the price matches that of the market. The asset ratio changes accordingly. Basically, since ETH is now worth double, the ratio has completely changed. On the Pool of 10,000 we now find 5 ETH and 2000 USDT.
- If Jean Pierre wants to withdraw these funds, then he will withdraw 10% from the pool. He will therefore obtain 0,5 ETH and 200 USDT.
- This is typically an example of a non-permanent loss. Instead of getting back 1 ETH that he had deposited, he will get back 0,5 ETH.
Even if overall he won, because in total, he receives $400 but if he had simply kept his ETH, he would have had $400 just with this one.
Of course, liquidity providers overlook this loss, because it is often offset precisely by transaction fees.
See? This is why you must be very vigilant when becoming a liquidity provider. This means you have to follow the courses closely and know when you need to rebalance your deposit.
This is why it is recommended to do it with very liquid liquidity pools (lots of exchanges) and with less volatile assets like stablecoins. These are generally the most “Secure” liquidity pools.
Beyond the risk of impermanent loss, there are other risks such as that a pull regime occurs and that one person will siphon off the entire pool.
Method #3: Become a yield farmer
Farming on DeFi is the most surprising activity on DeFi. It is in fact a (logical) continuity of liquidity mining. This is also why many people conflate the two types of process.
When you do liquidity mining, you receive liquidity tokens in exchange for your deposit.
Thus, while those who do liquidity mining seek above all and mainly to recover commission costs, farmers are more interested in the LP tokens that they receive.
LP tokens are specific to pools and they represent the share that has been deposited in the pool. They were originally created to give us a sort of “receipt” for our deposit. Thus, it is by giving back the LP tokens that the smart contact of the liquidity pool returns to us our deposited funds + the fees earned.
Very quickly because the story is long but the one who propelled this type of activity was Compound and its $COMP token…Basically, people who tiled Compound received $COMP for their efforts (like bonus points). rewards). Then, this simple governance token experienced a real rush on the secondary markets and this is where LP tokens were “diverted” from their main uses.
You could say that’s where it all started. Some wanted to earn some ($COMP tokens) for speculative purposes. On launch day June 17, 2020, COMP was worth $64 and 6 days later it was $350.
This is where it all started and lending protocol developers started to take notice and want to do the same. This is how governance tokens appeared like Aave with $LEND and it has continued to grow.
Initially, the protocols launched LP tokens as governance tokens to allow voting on the network. That
This is where the people came in and developed the idea of Yield Farming.
This is why we talk about Yield Farming. Farming simply refers to the idea of “cultivating” your new tokens which are those that you receive from liquidity pools.
Thus, there are now “farms” in which LP tokens can be locked (to earn other similar tokens or even other tokens.
When we farm, in fact, and very clearly, we are staking. To be clearer, tell yourself that the farmers are liquidity providers who stack LP tokens, that's all.
It’s also in farming that we see the highest APY rates with sometimes 4-digit sums….But hey, when it’s too good, you think there’s a problem…
Now, we must ask ourselves if these protocols in question are viable in the long term….
Final word on activities to make money on DeFi.
We invite you to follow the next training video and read the linked article to find out the best platforms that we recommend.
Indeed, now that you better understand the mechanisms underlying making money, you still need to find the right cryptos and the right platforms.
You will also need to have good tracking tools because you can quickly get lost among all the offers. For example, there are portfolio aggregators like Zerio, Zapper, Debank or Rotki which will allow you to monitor your investments.
There are also aggregators like Plasma.Finance which show you graphs to see in real time the best APYs according to the Pools and to follow them on different portfolios.
With the methods we have just seen, everyone can ultimately benefit from it and make money. It has never been so easy, accessible and open to everyone to make money.
However, always be wary of scams, dream sellers, and overly tempting APYs.
Always pay attention to whether the platforms on which you deposit your funds are audited.
We will also see the criteria to take into account when choosing your cryptos and platforms. It is indeed essential to make good money on DeFi.
What about security? Earn money only via decentralized services?
We add an additional remark here. In this article we will tell you about the protocols and dApps on the Challenge but we will also mention the equivalences on centralized sites. For a complete beginner, it may be useful to use both versions of the methods. On centralized sites, what we call “non-custodial”, these are the companies that manage your funds. This may be more “reassuring” for some people.
Indeed, these companies are under the control of the AMF for example and other financial authorities. They have a dedicated team for fund security. All of this may turn out to be less scary for a beginner. Indeed, I remind you that on DeFi, if a hack, a hack or a Rug Pull happens, you have no shoulder to cry on….There isn't even a support email address for many protocols…Developers on a decentralized protocol are on the same level as everyone in the community… That's what you have to remember.
That said, when we analyze certain smart contracts, we realize that sometimes the development teams have much greater power than the other members or that sometimes quite simply, the contracts are very vulnerable... What I want to tell you is that In terms of security, the ideal is not to put your eggs in one basket.
Finally, this is still just the beginning of making money on DeFi; Stay tuned for the rest which is even more interesting/.
Watch the video of 4 methods to make money on DeFi:
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Disclaimer: This content is for informational purposes and does not constitute financial advice. We strongly advise our readers to conduct their own independent research before committing to any investment.
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