You can start generating a passive income on your crypto holdings and it’s easier than you might expect. Learn how to get started in our guide.
- An Overview of Yield Farming and Liquidity Mining
- An Overview of Staking
- What Platforms Offer DeFi Applications?
- What’s the Future of DeFi?
Want to start earning a passive income? It may be easier than you think. And your cryptocurrency holdings could be the key.
Let’s start by talking about Decentralized Finance (DeFi). This is an ecosystem built on the blockchain, providing users with smart contracts and financial Decentralized Apps (DApps). These have the capacity to transform the traditional financial system (Centralized Finance) for good.
How? By replacing conventional services with trustless protocols.
The most important attribute of DeFi is the lack of a middleman. This leads to lower transaction fees and gives users total control of funds. Users can also access DApps no matter where they are, without geographic restriction.
All this may have been the stuff of fantasy years ago, but now users can take advantage of decentralized exchanges, prediction markets, lending platforms, tokenization platforms, and payment platforms with ease. And all without the middlemen.
DeFi brings vast opportunities that will revolutionize centralized financial models that have been in place for so long. DeFi platforms mean extra investment options, better interest rates, and capital protection.
So, we’ve covered the fundamentals of DeFi services. But how can you leverage them to generate a passive income through your crypto holdings?
An Overview of Yield Farming and Liquidity Mining
Yield farming enables you to start earning from your cryptocurrency holdings, rather than simply storing them in your wallet. You would lock your cryptos and accrue rewards according to the amount of coins you choose to lock.
But how will locking cryptos affect the ecosystem? DeFi can solve the liquidity problem through liquidity providers (LP). These individuals pool funds to create liquidity that supports a DeFi protocol. LPs choose to lock their coins to earn rewards, so they can also be referred to as yield farmers or liquidity miners.
Yield farming relies on two parties: the DeFi protocols and LPs. They form a symbiotic (and mutually beneficial) partnership.
Yield farmers bring liquidity for protocol support, and they receive rewards in return as a show of gratitude for supporting the system. Said rewards are typically taken from trading fees created by the underlying DeFi platform.
Binance smart chain and Ethereum protocols both support yield farming platforms. They use Binance Smart Chain (BSC) and ERC-20 tokens respectively.
How Does Yield Farming Function?
Yield farmers are a key element of structures that power those platforms using automated market maker (AMM).
These individuals deposit funds into a liquidity pool powering a marketplace that enables users to borrow, exchange, or lend their crypto tokens. These users would need to pay fees that reward yield farmers, based on their respective liquidity pool share.
But there’s another incentive motivating LPs: distributing a new token, typically a governance token of the protocol. Yield farming creates a solid passive income stream for cryptocurrency holders, but there’s a common risk LPs should be aware of: impermanent loss.
What does this mean? Impermanent loss results when the price of an asset in a liquidity pool changes (compared to the price at which it was previously deposited) in relation to the pair’s other asset.
If this price change is substantial, this will create more risk of impermanent loss – in other words, the value will be less at the point of withdrawal than when the deposit was made.
The loss is described as “impermanent” as it will disappear when the asset reverts back to the price at the time of deposit.
Here’s one way to get around impermanent loss: using tokens of low volatility (i.e. stablecoins) for yield farming. Their annual yield tends to be lower than those with high volatility.
An Overview of Staking
Before we can make sense of how staking functions, we need to understand the Proof of Stake (PoS) mechanism.
The PoS concept is a form of blockchain consensus mechanism enabling an individual to perform mining or block transaction validation in accordance with the number of coins they hold. This differs from Proof of Work (PoW), that sees miners solving a complicated puzzle in exchange for an incentive.
How Does Staking Function?
Staking functions in a similar way to yield farming: you lock up your crypto holdings to earn rewards.
But there’s a key difference. Yield farmers typically deposit two coins or tokens in a 50:50 ratio, and the user will receive LP tokens that are staked in the liquidity pool. However, with staking, you would stake a single coin or token into a staking pool to gain a reward.
Impermanent loss is no problem in staking. Why? Whenever a user removes their stakes, they will receive an equal number of coins no matter the difference in the asset’s price at the time of withdrawal and staking.
Those who stake have an opportunity to earn via incentives from the protocol and growth in the staked asset’s price, with no danger of impermanent loss.
What Platforms Offer DeFi Applications?
The popular DeFi protocols were based on Ethereum protocol once upon a time. As a result, passive income in DeFi was available on the Ethereum ecosystem only.
But the need for an alternative grew, as the Ethereum network wasn’t cost effective any longer. Transaction fees had increased to an unbelievable level, and there was a real issue with scalability.
That’s when Binance Smart Chain was established. And so far, it has been fit for purpose.
BSC essentially solves the problem of the huge fees common in the Ethereum network. Reducing fees to the minimum has opened up more room for extra projects to seamlessly build on the chain.
DApps (e.g. Farmswap, Burgerswap, Pancakeswap) are built on BSC, creating platforms on which cryptocurrency holders can easily generate passive income from their long-term holdings. They’re all available via the Trusted Wallet DApp browser.
One new DApp on BSC, Beefy.finance, optimizes yield farming over a number of platforms. This DApp provides users with automation that enables investors to interact with projects, pools, and additional yield opportunities with no need to make decisions or manually perform actions.
Users can achieve bigger, more secure returns with less effort or technical knowhow.
On the Ethereum protocol, DApps offering opportunities include Balancer, MakerDao, Synthetic, Uniswap, and more. Yearn.finance is the equivalent of Beefy on Ethereum.
How can You Access DeFi DApps?
The majority of cryptocurrency wallets available enable you to access DApps via their Decentralized Application search sections. Trust Wallet is one option that stands out, due to the support it offers for most BSC protocols (and some Ethereum ones). You can access Trust Wallet (with an in-built DApp browser) via an Android or iOS app.
What’s the Future of DeFi?
DeFi’s innovation goes beyond just removing unnecessary financial interference by third parties – it’s also providing users with more varied opportunities to profit, such as generating a passive income. The simple, unbiased potential to make money with little effort will continue to bring more users into the ecosystem.
You could start generating profits from your cryptocurrency holdings quickly and easily with DeFi. But do your research carefully to ensure you make an informed choice that offers real benefits in the long run.