How to Make Money With Smart Contracts

Smart contracts are self-executing agreements with terms directly written into computer code and stored on a blockchain. These digital contracts automatically carry out predefined actions when specific conditions are met, eliminating the need for intermediaries. This automated, transparent, and tamper-proof nature allows for trustless transactions across various digital platforms. Smart contracts have opened diverse avenues for individuals to generate income within the evolving digital economy, ranging from participating in decentralized financial systems to engaging with digital collectibles and gaming.

Participating in Decentralized Finance (DeFi)

Decentralized Finance (DeFi) leverages smart contracts to offer financial services without traditional intermediaries. Individuals can earn income by engaging with these protocols through methods such as lending, providing liquidity, yield farming, and staking.

One method involves lending cryptocurrency through smart contract-based platforms like Aave or Compound, allowing users to earn interest on their digital assets. Lenders deposit their crypto into a smart contract, and borrowers can then access these funds by providing collateral. Interest rates vary based on supply and demand within the protocol.

Providing liquidity to decentralized exchanges (DEXs) like Uniswap is another earning strategy. Users deposit pairs of assets into a liquidity pool, enabling others to trade between those assets. In return for supplying this liquidity, providers earn a portion of the trading fees generated by the pool. However, liquidity providers face impermanent loss, which occurs when the prices of deposited assets change significantly relative to each other, potentially reducing the value of their holdings.

Yield farming extends liquidity provision by strategically moving assets between different DeFi protocols to maximize returns. This often involves staking liquidity provider (LP) tokens into other smart contracts to earn additional rewards, sometimes in the form of governance tokens. Yield farmers constantly seek the most profitable opportunities, which can involve complex interactions across multiple smart contracts and platforms.

Staking involves locking up cryptocurrency in a smart contract to support a blockchain network’s operations, such as validating transactions or securing the network. In exchange for committing their tokens, stakers receive rewards, typically in additional tokens. Staking allows individuals to earn passive income by contributing to the stability and functionality of a blockchain ecosystem. Income from staking rewards is subject to ordinary income tax based on the fair market value of the tokens when received.

Creating and Trading Non-Fungible Tokens (NFTs)

Non-Fungible Tokens (NFTs) are digital assets with unique identifiers recorded on a blockchain, verified through smart contracts, ensuring authenticity and ownership. The IRS generally treats NFTs as digital assets, similar to cryptocurrencies, subject to capital gains tax upon disposal and income tax when earnings are generated.

For creators, smart contracts facilitate the “minting” process, which is publishing an NFT on a blockchain. Artists and creators can program royalties directly into the NFT’s smart contract, ensuring they receive a percentage of the sale price each time their NFT is resold on a secondary market. These royalty percentages are typically set between 5% and 10% by the creator at the time of minting. Income from NFT sales for creators is generally taxed as ordinary income, subject to federal rates ranging from 10% to 37%.

Individuals can also earn money by trading NFTs on secondary marketplaces. This involves buying NFTs and selling them later, ideally at a higher price, based on market demand and perceived value. When an NFT is sold for a profit, the gain is subject to capital gains tax. If held for less than a year, it’s a short-term capital gain, taxed at ordinary income rates. If held for more than a year, it’s a long-term capital gain, subject to lower rates (0%, 15%, or 20%). Some NFTs may be classified as collectibles and taxed at a higher long-term rate of up to 28%.

Engaging with Blockchain Gaming

Blockchain gaming, often referred to as “play-to-earn” (P2E), uses smart contracts to create verifiable ownership of in-game assets and facilitate player-driven economies. Players can earn cryptocurrency or NFTs through gameplay, which can then be sold or traded for real-world value.

Earning mechanisms in blockchain games include completing quests, winning battles, breeding digital creatures, or owning virtual land that generates income. Players might earn in-game tokens as rewards for achievements, or acquire unique NFTs representing characters, items, or land. These tokens and NFTs can often be sold on secondary markets, allowing players to convert their in-game efforts into tangible earnings. The income earned from playing these games, whether in cryptocurrency or NFTs, is generally taxable. When cryptocurrency is received as a reward, it’s treated as ordinary income at its fair market value at the time of receipt. Subsequent sales of in-game NFTs or tokens are subject to capital gains tax, similar to other digital assets.

Developing and Auditing Smart Contracts

Individuals with technical expertise can directly contribute to the smart contract ecosystem by developing or auditing these digital agreements. Developers are crucial for designing, coding, and deploying smart contracts for various applications. This role requires proficiency in programming languages like Solidity and a deep understanding of blockchain architecture. The demand for skilled smart contract developers is high, with average annual salaries ranging from $100,000 to over $200,000, depending on experience and location.

Smart contract auditors play a role in ensuring the security and reliability of these digital contracts. They review smart contract code for vulnerabilities, bugs, and potential exploits that could lead to financial losses. This involves detailed code analysis and security assessments. Auditing is a highly specialized and in-demand service. Auditors generally command competitive compensation, often similar to or exceeding that of developers, given the security implications of their work.