What is DeFi? Decentralized Finance or DeFi is a financial system based on the blockchain and smart contracts. In DeFi, finance is designed to provide an alternative to traditional financial institutions, such as banks and brokerage firms.
DeFi crypto projects are growing by leaps and bounds, with their popularity ensured by the following advantages of the DeFi economy:
- Complete decentralization
- Absolute transparency
- Unprecedented accessibility
- Little to no bureaucracy
How DeFi works
Most decentralized applications (DApps) and platforms powering the DeFi system are built on the Ethereum blockchain. Smart contracts (aka algorithms) operating on the blockchain eliminate intermediaries and allow DApps to be fully decentralized.
The absence of intermediaries for transactions between users also makes DeFi financial transactions more reliable. The blockchain provides all transactions with protocols that ensure that no transaction can be altered or forged in any way, shape or form.
How to make money on DeFi
DeFi crypto services can be extremely profitable, generating stable passive income for many crypto investors. Here are the two most common ways to make money on DeFi:
DeFi crypto Lending & Borrowing
Many dApps allow you to borrow crypto using another cryptocurrency or fiat currency as collateral. You deposit your digital assets on a platform, which is then fixed in a smart contract and remains there until you repay your loan. The difference between borrowing DeFi coins and fiat money in a bank is that in DeFi, loaned funds are provided to the smart contract directly by its other users. The lender receives interest as long as the loan is secured by collateral.
To ensure the safety of loans, many DeFi crypto lending platforms resort to a practice called over-collateralization. In this practice, if you want to borrow some money, you first have to deposit your own, in an amount exceeding (normally in the 1:2 ratio) the size of your desired loan.
Let’s take a look at DAI, a decentralized Ethereum-based stablecoin released for the MakerDAO smart contract platform. The Maker protocol sets the size of the collateral in the 1:2 ratio, meaning that you’ll have to lock $200 in ETH in a smart contract to get $100 in DAI tokens.
If you fail to repay the borrowed funds, the coins locked by the smart contract are transferred to the lender’s account.
Yield Farming aka Liquidity Mining
Yield farming is another option for making profits on DeFi. In many ways, it’s just like ‘normal’ farming, but with a slight difference: instead of plants, you’re growing cryptocurrencies.
You lock up your assets on a DeFi finance platform, and in return receive the passive income generated during the growth of the cryptocurrency. You can access this method in most dApps, for example, YFI (Yearn.Finance), as well as on decentralized exchanges (DEXes), such as Uniswap and Sushiswap.
Holders who lock up their DeFi coins form a liquidity pool that other users draw money from to use for trading and other purposes. The reward may vary depending on the share in the pool. For each trade executed on a DEX, the trader pays a commission, which then goes to the farmers in proportion to the share invested.
Participation in DeFi finance without risk
DeFi coins can be just as volatile as any other crypto asset. Still, there is one reliable way to avoid having to do a lot of research and embrace the reality of running risks when choosing a new project.
You can use a part of your idle crypto assets for staking — locking them up on an exchange and thus earn passive income. You can stake cryptos on just about every more or less developed crypto exchange out there — Binance, Kraken, Coinbase, Crypto.com, etc. Keep in mind, however, that there are different types of staking that have different underlying conditions. Read more about staking here.