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How To Profit Off The $219 Billion (And Growing) DeFi Sector

It was inevitable for Bitcoin to launch. Roger Ver even said the Bitcoin ledger was the single most important innovation after the internet. Q3 2021 hedge fund letters, conferences and...

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This story originally appeared on ValueWalk

It was inevitable for Bitcoin to launch. Roger Ver even said the Bitcoin ledger was the single most important innovation after the internet.

the-design_org / Pixabay - Valuewalk

Q3 2021 hedge fund letters, conferences and more

The traditional finance scene finds itself in stasis. This is how: It has been over forty years since SWIFT revolutionized finance, allowing for easy and "faster" cash flow across borders. The problem is-- its rails are under the control of centralized megaliths in banking that smoothers innovation to protect its turf. They watch every step. Besides, SWIFT as a solution is comparatively expensive and settlement isn't instantaneous.

The Bitcoin Lint

The anonymous and mysterious creator of Bitcoin, Satoshi Nakamoto, wanted something different to escape the chaos of the Great Financial Crisis of 2008-09. The protocol launched and has grown to be a disruptive and highly adopted force.

Just recently, through its principal regulator, the Securities Exchange Commission (SEC), the U.S government approved of an Exchange-Traded Fund tracking Bitcoin Futures. It is a watershed moment for crypto marking the age of institutionalization.

DeFi Expands On What Bitcoin Built

While Bitcoin focuses on remittance and is purely a transactional layer, the advent of smart contracts on Ethereum ushered in a new era extending what digital gold offers. After several years of experimentation, DeFi dominates smart contracting as an emerging asset class that even regulators in the United States note as essential development. They acknowledge the decentralization of the underlying technology and the power of the community behind DeFi as an innovation that could even help steady the global financial industry.

At the time of writing, there are over $219 billion of assets locked in various DeFi protocols across platforms such as Ethereum, the Binance Smart Chain (BSC), Polygon, Tron, and more. Since Ethereum is the first DeFi platform, it dominates activity, managing over $97 billion of various digital assets.

Incentivization And Income Diffusion Is The New Cool

What's interesting about DeFi is the incentivization aspect. It builds on what makes its base layer—Ethereum—or any other smart contracting platform--robust, rewarding participants. For example, successful Ethereum miners receive 3 ETH after every other block. In DeFi protocols, participants, who, for instance, stake their coins or supply liquidity to decentralized exchanges' liquidity pools, are rewarded with the platform's native token.

Considering the solutions offered by the different DeFi protocols in finance, their tokens are valuable, often commanding billions or hundreds of millions in market cap. According to trackers, the most valuable DeFi tokens—Uniswap (UNI), Terra (LUNA), and Avalanche (AVAX)—cumulatively have a market cap of over $40 billion. The figure could be higher with increasing adoption and entry of new users angling to earn income from DeFi.

DeFi Is Community-Driven And Income Generating

There are no barriers to entry in DeFi since the space is open source and community-driven. As a result, even new users without prior experience in blockchain can find hooks in the sphere and a chance to earn income. What's more, there are various strategies to use to earn an income in DeFi. Sometimes, these opportunities can be found in a single application. The Nimbus Protocol, for instance, is a duo-token platform operating as a DAO in Ethereum and the Binance Smart Chain (BSC). Community driven, the platform allows users to sustainably earn income from multiple streams, including lending, staking, through P2P services, and more. In total, the protocol provides 16 different revenue streams for users while operating as a DAO registered in Malta. Presently, there are over 57k users connected to the platform with at least 28k active wallets pinged to various countries across the globe.

The Kava Protocol can also be an alternative for users. It is interoperable and recently activated Kava Lend—previously the Hard Protocol—a multi-chain money market trustless operating on the scalable, cross-chain layer. Besides, users can also stake assets to earn income. Overall, this protocol can be described as a cross-chain DeFi hub operating as a trustless bank connecting users with digital asset products like stablecoins, loans, and interest-bearing accounts.

On platforms like Yearn Finance, users have a chance to earn income from DeFi through yield farming. The protocol operates as a yield aggregator, allowing its users to earn YFI tokens when they lock digital assets on its contracts running on Curve and Balancer using Yearn Finance. However, the protocol has several products like Earn, Zap, Vaults, and APY. Through Earn, for instance, the protocol can automatically pick out which asset offers the highest lending rates for its users. On the other hand, the vault comprises various investment strategies allowing users to earn highest returns from other DeFi projects.

Top 3 Income Earning Strategies In DeFi

While income generating streams are many as illustrated above, these are the top three income earning methods in open finance:

  1. Lending

To get started here, DeFi users need to acquire ETH or any other high-profile ERC-20 fungible token like, say, Chainlink (LINK) or a stablecoin. Once a user gets past this hoop, it is straightforward what they can do next: Lend. The process is trustless, paperless, and entirely controlled by an audited, secure smart contract.

The user lends their asset, which is then locked in the protocol for a given period in exchange for interest rates which are usually higher than traditional interest-bearing accounts offered by banks. Borrowers can then access this facility, receiving loans that are overcollateralized, protecting the network against unexpected shocks. Besides, it guarantees that the collateral can sufficiently cover the loan taken just in case of a default.

  1. Staking

A user can also choose to stake their assets. However, it should be noted that staking only applies in Proof-of-Stake consensus platforms. These blockchains include Cardano, Algorand, Tezos, and many others. There are various ways of staking. A user can run a full node and lock the minimum amount set by the network to qualify in validating transactions in exchange for block rewards.

In Tezos, for example, a user must stake at least 8k XTZ coins to qualify as a validator (baker). Meanwhile, in Eth2, the minimum is 32 ETH. Since these requirements are steep, staking can be done through an exchange like Coinbase or Binance or delegated through third-party providers. In all, stakers earn passive income higher and thus attractive.

  1. Liquidity Provision

Decentralized exchanges like Uniswap or PancakeSwap depend on liquidity providers who supply assets to listed liquidity pools. In exchange for supplied liquidity, they receive a share of the exchange's revenue, which is earned from transaction fees, represented as Liquidity Provider tokens.

While attractive and seemingly providing an opportunity for passive income, a user can lose money through impermanent loss caused by fluctuation of asset prices, sometimes wiping out gains received from liquidity provision.

Conclusion

DeFi is a drawer guided by smart contracts launched on trustless environments without KYC and AML requirements. This explains the billions of assets locked in various protocols. Analysts maintain that the sphere is still nascent. More innovation anchored on automation would continue to release more income-generating opportunities for users.

Nonetheless, while attractive, users shouldn't participate blindly. There have been multi-million losses through rug pulls and exploits. As such, users, regardless of their adopted strategies, must do their due diligence, avoiding unaudited smart contracts to remain safe.