How to Make Money with DeFi, DAO's & CryptoDec 06, 2021
As if buying and selling certain tokens wasn't confusing enough - today we are going to introduce a new way to make money in crypto.
And that is through something called DeFi - also known as Decentralized Finance.
So, what is decentralized finance? A word that is becoming more and more common, DeFi is an umbrella term for financial services that run on blockchains. With DeFi technology, people can serve most of the functions that traditional banking historically has. That includes: earning/paying out interest, lending & borrowing, insurance, providing liquidity, etc.
Of the main value-adds provided by DeFi is that this financial service is faster and doesn't require a third party that takes excess fees. Think about all the intrinsic fees you need to pay back when you use a bank (office space, salaries, etc.)
With DeFi, because there is no centralized hub, most of this is avoided. This creates markets that can be accessed by anyone with an internet connection!
Whether you understand or don't understand what we're saying - the most important thing is that DeFi technology has the power to revolutionize modern finance.
And while buying crypto is a good way to get involved in the industry, making passive income is now very possible through this relatively new financial institution! Let's get into it 👇
DeFi + Crypto Lending Overview:
The traditional thought in crypto and most financial markets is that in order to make money investing you need to buy assets at low prices and sell them at high prices in order to turn a profit.
However—as we suggested above—there is a less risky way to turn a profit and that is through DeFi. In the world of crypto, if your coins go down in value you're subject to some serious losses but in the world of DeFi, if the coins go down in value our income is not affected at all!
Let's focus on the main way this is possible:
- The first way it is possible is via lending. In DeFi lending, you let other people borrow your crypto! This should sound familiar because we've recently talked about it via BlockFi (see it here). But BlockFi is actually a form of centralized lending, not decentralized. While the two are very similar, and are both great ways to make passive income, BlockFi relies on a central authority. And just like we discussed above, with banks, you are paying fees to BlockFi in order for them to continue supporting their financial products.
So what are the main benefits here?
- Lower fees: While this centralized exchange gives people a sense of comfort, many of these fees can be avoided by doing this same exact action but via a DeFi platform instead (more on this below).
- Higher rates of return: In DeFi platforms not only are you avoiding fees but the rates you get paid are usually higher - sometimes near 30%+!
- These flash loans are mostly overcollateralized: Do you remember back in 2008 during the mortgage crisis when no one had enough money to pay back their debts. Well, this happened because the loans they took out were actually bigger than the assets they had on hand. But in the world of DeFi, every loan is overcollateralized. This means that if you want to borrow 100 USD of Ethereum, you need to actually put down 120 USD. So if prices fluctuate, there is a run on the bank, or the loanee defaults you'll always have access to their initial deposit, thus mitigating your risk.
While there are some risks, like hacks and no centralized finance platforms to try and recover lost funds, the benefits are that these are still relatively safe, are fully open source (which means full transparency), and are considered a crypto interest account as they provide cheaper/ higher "interest rates"
So if you're wondering which are our favorite platforms, two of them are Aave & Compound.
They have lending rewards as little as 2% annually and others as high as over 100%! For the risk, Polkadot is paying out near 20% and is one of the best rewards we see on Compound & Okex specifically (see it here).
DeFi + Crypto Liquidity Overview:
The second way this is possible is by providing liquidity to DeFi platforms. This is another way to earn yield but is more risky. Let us explain what this actually means though 👇
- In the world of stock exchanges, these exchanges exist to match buyers and sellers. If you want to sell a stock of apple, that exchange finds you an individual buyer/buyers and vice versa.
- But in crypto, these platforms don't use people but rather use code to make this faster and more efficient. They also use algorithms and pools of money in order to simulate the buyer/seller experience. So if you want to make a trade you go to the pool and the algorithms tell you how much crypto they can give you for your money and vice versa. And this all comes from pooled liquidity!
But the money in the pools don't come out of thin air, they come from people like you and I who provide the digital asset that traders can trade against! And by providing liquidity to the pool, you get paid directly from the fee's traders pay in order to use the pool!
If we lost you the summary here is:
Pools of liquidity are created in order to form more efficient trading exchanges
These pools are created via people who provide liquidity
These people provide liquidity for the purpose of getting paid from the fees traders incur
While this is a great way to get paid, the inherent risk with this is due to something called impermanent loss. This phenomenon occurs when you provide coins/assets to the liquidity pool that go way up in value. If they go way up in value, you would have just made more money holding the coin than you would from the fees paid out to you. The short of it is that you're shorting volatility here in exchange for income. If you want to understand this point further, check out this really helpful: video
The takeaway here is that highly stable coins pose less risk, while highly volatile coins pose more risk. Here's how you can provide liquidity from less to most risky:
Liquidity to stablecoin because in theory it'll always stay constant. Thus mitigating the price volatility we discussed above.
Liquidity to strong assets like Bitcoin $BTC and Ethereum $ETH that trade closely in pairs and you'll get a decent fee. More price fluctuations but not nearly as many as the next one.
Liquidity to unstable coins. They usually give super high incentivizes in order to pull people into providing liquidity for these coins. They can sometimes pay over 400% APY! The risk is though if the token crashes, you could lose a decent amount through impermanent loss. The upside is crazy because we know of people who invested $250 in liquidity pools like this and made $17,000 in exchange - although this is a fringe case and does not happen often!
One of the biggest and most important DeFi projects are DAO's also known as decentralized autonomous organizations.
Unlike public companies that make decisions via shareholders & board of directors and then implement them via employees, DAO's make decisions via coin holders and let the code execute itself - taking the trust out of the equation. While you must trust that employees will execute the decisions and execute them well, in a DAO there is no CEO, no one to rely on and once the changes are voted on, the code handles the rest of it and takes humans out of the equation.
And the cool thing about this is that DAO's can evolve so as long as the collective votes on them! So in the crypto world, votes are represented by tokens. More Tokens = More Votes -> Therefore inherently giving the value of the coin.
So whoever has the most coins has the biggest say and as things come up the DAO votes on changes, who to hire, salaries, etc. and pays everyone out in crypto of the DAO.
That's why DAO's have become so popular because rather than just having zero value associated with a coin that's being pumped by the reddit community, these DAO's are organizations where tokens not only represent value in the form of voting rights but also represent profit derived from the DAO.
So if the DAO has profit and pays it out, if you were in that DAO you'd get paid too as it becomes more or less profitable!
- It is trustless
- The only way things would stop running is if a majority coin holder submitted a proposal to do so and then had enough money to make it happen
- DAO's are open source and fully transparent.
- Code is open source so it can be vulnerable to attacks.
- No business secrets. R&D is usually locked away and companies bet on this R&D to one day pay off. But in a DAO this is all open source, so anyone can steal an idea from anyone whenever.
Some DAO's we’re watching for potential investment are:
- Olympus DAO
We'll be doing a much longer post and video on Olympus DAO soon!
Incentives & Airdrops:
The last way to make money through the DeFi platform is through incentives and airdrops. Let's use the following as an example:
Imagine you're in charge of advertising for a blockchain-based company. You could buy digital ads or a billboard but most people realistically won't get it nor will they trust your company.
So to solve this problem many projects are literally giving away free money to people using their blockchain - aka airdrops.
This gets early adopters truly excited and gets their friends and family using it. This is happening right now with many projects and Avalanche $AVAX is a great example of it. They are doing this by giving away literal free money.
They gave away $720M worth of tokens to date.
By paying users, companies are incentivizing people to not only sign up but continue to use it because this could happen at any point!
While it is impossible to predict which companies are going to airdrop giveaways, things to watch out for is:
- Huge rounds of VC funding for these projects
- Twitter hype around these projects
- Mass adoption
We realize that this is a lot to digest, even for experienced crypto investors but this is a huge area being invested in that most people are missing out on. DeFi gives investors a chance to make money in a way never possible before!
We're truly excited about the future of many of these DeFi projects above and can't wait to see how it all plays out.