What is DeFi and what are the ways to make money?

DeFi

This stands for decentralized finance. If you’ve read the article carefully, you know exactly what it is. I won’t explain it again. If you don’t understand, go back to the explanation at the beginning of the article.

DeFi is the implementation of traditional finance, but in a decentralized world. You can trade on a DEX without creating accounts, you can take loans without verification, or conversely, lend coins and earn some interest, and much more. And all of this is based on smart contracts, meaning everything is super transparent.

So, in simple terms, DeFi provides the opportunity for passive income – just deposit your money into some protocol and watch the interest accumulate. To be honest, I’ve never farmed in DeFi, but I have some experience that I want to share with you.

Ways to Earn on DeFi

There are several ways to increase your money. Let’s list them in order, and then we will go over them in detail:

1. Staking
2. Liquid Staking
3. DeFi Staking: Yield Farming + Liquidity Mining
4. Lending

There are many unfamiliar terms, but they all have one thing in common – you provide liquidity to someone for a period of time and earn a commission for it.

Staking

Let’s remember what Proof-of-Stake is.

The Bitcoin blockchain works only because there are many computers around the world that solve complex mathematical problems requiring huge computing power. This method of blockchain operation is called Proof-of-Work, literally – proof of work.

But blockchains like Ethereum and Solana don’t require such large computing power. To make these blockchains work, many computers are needed where ETH and SOL coins are temporarily locked. For staking their coins, people receive rewards from the blockchain itself. This type of earning is called Staking.

On the screenshot above from the website, you can see the most popular staking options. For example, you can stake 1 ETH, and after a year, you’ll have approximately 1.035 ETH. Essentially, it's free and very easy money (you don’t have to do anything), but the problem is that the price of ETH a year from now could be absolutely anything, for example, it could drop by 90%.

But if you believe that in, let's say, 5-10 years, ETH will be much more expensive, then staking is the perfect option, and in this way, you also get free coins on top.

Liquid Staking

However, there is a significant problem with staking directly into the blockchain – the entry threshold. For example, in the Ethereum blockchain, the current entry threshold is 32 ETH, which is currently valued at a whole 115,000 dollars. But liquid staking protocols come to the rescue.

The principle of liquid staking is very simple:

1. A pool of contributors is formed who bring their ETH.
2. Once 32 ETH are collected, the project takes care of all the technicalities and stakes the ETH.
3. The project takes a small commission for its work. For example, if direct staking brings 4% annual interest, the project might take around 0.5%, and your ETH will yield 3.5%.
4. All profits are shared among the contributors.

DeFi Staking

In fact, the two previous points were described to smoothly transition to DeFi staking. In classic staking, the reward is paid directly by the blockchain for holding assets in your own wallet. There are no third parties involved in the transaction, and your funds are always accessible. In the DeFi version, intermediaries – people and organizations – take your coins for interest. The security of the transaction is ensured by a smart contract, and it entirely depends on the presence or absence of vulnerabilities in it.

Also, DeFi yields are significantly higher, and the entry threshold is lower. With traditional Proof-of-Stake, you typically can’t earn more than 10% per year, plus you need to run your own validator node (or give 5-10% of your earnings to third-party validators). In DeFi staking, interest is accrued daily and is immediately available for reinvestment. Proof-of-Stake guarantees returns, with the only risks being the coin price drop and blockchain hacks. In DeFi staking, there are no such guarantees, and, on the contrary, additional risks are present.

So, there are two main types of DeFi staking: Yield Farming + Liquidity Mining. For now, you don’t need to know the differences between them.

DeFi staking can be considered the equivalent of a bank deposit – you temporarily lock up your funds, and they pay you interest. For DeFi projects to function, they need liquidity, which banks provide in traditional finance, but in DeFi, anyone can provide liquidity and earn interest from it.

Wondering why a DEX can instantly execute a trade? That’s because it has a reserve of liquidity locked by users, which smart contracts use, and from each transaction, a small commission is earned by the user. This is the entire source of income for the user.

Lending

On platforms like Maker DAO and Compound, you can lend money with Ethereum as collateral. On the second platform, even those who take out loans can earn – with every loan transaction, additional tokens are generated, which are used to pay for exchange services.

The principle of this method of earning is similar to lending in any bank: the user borrows an asset, leaving collateral. However, DeFi offers a much more interesting model. Here, there’s no need for a passport or credit history; anyone can lend their money for interest. The intermediary in this case is the smart contract.

The essence of this earning method lies in providing your assets on specialized platforms. Using smart contracts, the platform lends your funds to other users who have provided collateral. The collateral is usually more than 100% of the borrowed amount.

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