How to Make Money With DeFi: Key Methods for Earning

Decentralized Finance (DeFi) offers financial services built on blockchain technology, operating without traditional intermediaries. It leverages automated agreements known as smart contracts to replicate and enhance conventional financial services like lending, borrowing, and trading within a decentralized, peer-to-peer framework. This article explores key methods for generating income within the DeFi ecosystem.

Setting Up Your DeFi Foundation

Engaging with decentralized finance requires a foundational setup. The initial step involves choosing and setting up a non-custodial cryptocurrency wallet, which gives you complete control over your digital assets and their private keys. MetaMask and Trust Wallet are popular choices, functioning as browser extensions or mobile applications.

To set up a wallet, download the extension or app, create a new wallet, and generate a unique seed phrase, also known as a recovery phrase. This phrase, usually a series of 12 or 24 words, is the master key to your funds. Securing this seed phrase offline and never sharing it is paramount, as anyone with access to it can control your assets.

DeFi protocols operate across various blockchain networks, such as Ethereum, Polygon, or Binance Smart Chain. Each network has different transaction speeds and costs. Your wallet must be compatible with the network you intend to use, and you may need to manually add or switch between networks within your wallet settings.

Before participating in DeFi, acquire initial cryptocurrency. This involves purchasing assets like Ethereum (ETH) or stablecoins (cryptocurrencies pegged to the value of a fiat currency) on a centralized exchange. Then, transfer these assets from the centralized exchange to your non-custodial wallet using its public address.

Every transaction on many blockchain networks, particularly Ethereum, incurs a fee known as “gas.” Gas fees compensate the network’s validators for processing and securing transactions. These fees fluctuate based on network congestion and operation complexity, paid in the network’s native cryptocurrency, such as ETH for the Ethereum network.

Earning Through Decentralized Lending and Borrowing

Decentralized lending and borrowing platforms allow individuals to earn interest by supplying cryptocurrency to a pool of assets. These platforms rely on automated smart contracts to manage the process. Users deposit digital assets, which become available for others to borrow, with interest rates determined by supply and demand.

Prominent protocols include Aave and Compound. When you deposit cryptocurrency into a lending pool, you receive a token representing your share, such as aTokens on Aave or cTokens on Compound. These tokens accrue interest in real-time.

To participate, connect your non-custodial wallet to the lending platform, select the cryptocurrency to lend, and approve the transaction. The platform’s smart contracts manage fund allocation and interest collection. Borrowers provide collateral, often exceeding the loan value (overcollateralization), to secure borrowings.

Interest paid by borrowers is distributed among lenders proportionally to their contribution to the liquidity pool. This creates a peer-to-peer interest-earning opportunity for cryptocurrency holders.

Earning Through Liquidity Provision and Yield Farming

Decentralized Exchanges (DEXs) facilitate token swaps using Automated Market Makers (AMMs) and liquidity pools. Users become liquidity providers (LPs) by contributing pairs of tokens to these pools, enabling others to trade. LPs earn a share of the trading fees generated by swaps within their provided pool.

For example, on platforms like Uniswap, LPs deposit an equal value of two tokens, such as ETH and a stablecoin. Each trade incurs a small fee, typically 0.25% to 0.30% of the transaction value, distributed to LPs based on their proportion of the pool’s total liquidity.

A characteristic of providing liquidity in AMM pools is impermanent loss. This occurs when the prices of deposited tokens change relative to each other. If the price divergence is significant, the value of your assets in the pool might be less than if you had simply held the tokens. This loss is “impermanent” because it only materializes if you withdraw liquidity before asset prices return to their original ratios.

Yield farming extends liquidity provision by offering additional token rewards beyond trading fees. Participants receive governance or native tokens from the protocol as incentives. These tokens can be sold for profit or staked in other “farms” to generate further rewards.

The process involves connecting your wallet to a DEX, selecting a liquidity pool, adding the required token pair, and receiving LP tokens. For yield farming, you then stake these LP tokens in a separate farming contract to earn additional reward tokens.

Earning Through Staking

Staking involves locking up cryptocurrency to support a blockchain network’s operations and security, earning rewards in return. Most staking opportunities exist on Proof-of-Stake (PoS) blockchains, where validators are chosen to create new blocks and validate transactions based on their staked cryptocurrency.

Native staking involves directly participating in a PoS blockchain’s consensus mechanism. On networks like Ethereum, Solana, or Cardano, individuals can stake assets to become validators or delegate their stake. Validators earn rewards for proposing and validating blocks, while delegators earn a portion of these rewards by supporting a validator.

Liquid staking addresses locked capital in native staking. Protocols like Lido or Rocket Pool allow users to stake assets and receive a liquid token representation. For example, staking ETH through Lido yields stETH, which can be used in other DeFi applications while the underlying ETH earns staking rewards. This offers flexibility and capital efficiency.

The process for decentralized staking involves connecting your non-custodial wallet to a staking platform or liquid staking protocol. You select the asset to stake and confirm the transaction. An “unbonding” period, ranging from days to weeks, may apply, during which your staked assets are locked when you unstake them.