Staking, Yield Farming, Lending: DeFi Remains Crypto's Home for Passive Income

The crypto market is barely 12 years old but has evolved so much since its inception that institutions and governments have been forced to take notice. In 2022, there is a lot of buzz around NFTs, the Metaverse, and P2E games. Decentralised finance and the services it offers however, remain invaluable to the crypto space.

De-Fi

DeFi is an acronym for decentralized finance. The term refers to an array of applications known as Dapps (Decentralized applications) built on a blockchain. DeFi seeks to create a financial ecosystem that is trustless, permissionless, and open-source. Giving users absolute control over their money.

DeFi has made access to financial services easier and with its farms, lending services, and staking rewards, the ecosystem is a go-to for profit-hungry investors. To access these services it's important to know where to look and what to do. Below, I examine the three most popular services on decentralized finance and what they are about.

Staking

There are different forms of staking in DeFi. The one that best describes staking involves locking a certain amount of crypto assets on a network to become a validator on that blockchain (Usually a Proof-of-Stake (PoS) blockchain network). Validators are selected mostly based on the number of assets they stake. This means users with higher staked assets will most likely be selected to validate transactions and earn rewards.

In return for locking these assets, users get rewards which are calculated in APR (Annual percentage rate). APR differs for different protocols and blockchains with certain blockchains offering APR between 13 to 20% while others offer in the hundreds. DeFi is highly risky and protocols that offer unreasonably high returns may not be sustainable in the long run.

Staking rewards are traditionally given to users in the original cryptocurrency they staked but some protocols may pay users in a second coin. Staking is one of the easiest ways to earn passive income in crypto. Certain centralized exchanges like Binance, Kucoin and Gate now offer staking services. The offer is however limited to a few cryptocurrencies and their limits to the amount that can be staked. The APR is also significantly lower compared to the ones offered on Dapps.

How to stake

To stake, you have to, first of all, find a cryptocurrency that uses a Proof-Of-Stake (PoS) mechanism. These can be found using sites such as CoinGecko, CoinMarketCap and Messari. Buy a PoS cryptocurrency and move to a wallet. Popular wallets include Metamask, TrustWallet, etc. Stake the cryptocurrency on the Dapp of the protocol.

Yield Farming

Yield farming has a lot in common with staking but a few differences. Yield farming is a smart contract service that allows users to earn more cryptocurrencies by proving their own cryptocurrencies. To fully grasp the concept of yield farming, there are two terms that need to be understood; liquidity pool and liquidity provider.

A liquidity pool is a smart contract that serves as the ‘pot of cash’ for a protocol. The people who provide the funds are known as liquidity providers. In yield farming, users add liquidity to a liquidity pool by staking their cryptocurrencies in them.

A major difference between staking and farming is that multiple assets are required for farming. If staking requires users to lock ‘token A’ and get more ‘token A’, yield farming requires users to lock ‘token A and B’ and get rewarded with more of ‘token A, token A and B or token B’. The returns are calculated in APY (Annual percentage yield) and vary across defi protocols.

Rewards are paid based on interest originating from the transaction fees levied on traders that use the protocol. The most popular yield farmsare on the Ethereum blockchain and as such most tokens are ERC-20. Some popular yield farming protocols include; Aave, Uniswap, Compound, Curve Finance and Sushiswap. Yield farms on the Solana, Avalanche and Fantom blockchains are currently drawing in LPs with their tantalizing offers.

How to farm

Ethereum was where it all started but farms with better APYs have opened on other blockchains like Solana and Polygon. Find farms using Coingecko. Buy the required cryptocurrencies and send them to a compatible wallet. Read the terms for providing liquidity and risks involved before locking your assets.

A common drawback of yield farms is losses that can be incurred through a process known as “impermanent loss”. It's a loss that investors suffer due to a sudden rise or drop in prices of assets they provide to an LP. Usually, their rewards offset these losses but for farmers who unstake before maturity, the loss could become permanent.

Lending

Another attraction for investors to DeFi is the loans that are available in the ecosystem. Defi lending platforms offer crypto loans to users in a trustless manner. This means there are no third parties involved. Users are also allowed to enlist their cryptocurrencies coins on the platform for lending purposes. When a borrower takes a loan, the interests they incur will be used to reward the lender.

Defi lending benefits both lenders and borrowers. It offers margin trading options, allows long-term investors to lend assets and earn higher interest rates. It will also enable users to access fiat currency credit to borrow loans at lower rates than decentralized exchanges.

Almost all the loans issued through native tokens are collateralized. What this entails basically is that users need to provide cryptocurrencies as a guarantee to take these loans. This is a departure from traditional banking systems where documents of ownership of landed properties or real estate would be required.

Points to note when lending or borrowing include APY, costs, lending limits, duration and minimum deposit limits.

How to Lend

Choose a reputable lending protocol and provide liquidity to the lending platform. Compound is one of the most popular and successful lending protocols in defi. The protocol has a diverse pool of cryptocurrencies for users to borrow or lend. A native token, COMP, is also offered to users who provide liquidity to the platform.