How to to make money in Defi

When most people talk about making money in Defi, they're usually talking about generating APY or APR % yields from crypto-assets that they have deposited.

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Example: On the Polygon/Matic network, using the Mstable Dapp you can currently earn 25% APR return on stablecoins that you deposit (crypto that's pegged to the price of $1, usually 1 USD). So if you deposited 1,000 USDC (~$1,000), over the year, you would receive $250.

25% interest paid out per year certainly sounds great - but where does that money come from? When the national savings account interest is 0.06%, how can these crypto dapps afford to pay 20%.

Let's take a high-level overview of where yields in Defi come from.

Lending

This is a pretty straightforward concept...you lend your assets to a platform by "locking" them in a smart contract. Depending on the protocol, you might be able to withdraw those funds whenever, or they may be locked for a set period of time. Borrows can access those assets as loans and then they pay them back with interest. The smart contracts distribute the interest accrued to lenders in proportion to what they lock in.

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Example: On the Avalanche blockchain, using the Benqi Dapp, you can deposit your crypto assets and earn a set APY as a reward for lending it to borrowers. You can currently earn ~10% by lending out DAI or 17% by lending out USDT.

What happens if borrowers default? Every Dapp is different and you should do your own research before engaging with anything. Most money markets in Defi operate off of fully- and over-collateral loans. This means that borrowers have to deposit as much or more than what they borrow. This isn't the place to go into the details of liquidation and collateral-ratios but just know that the good lending defi applications have sufficient protections in place for lenders.

Staking

Staking is a term you'll hear a lot in crypto...it usually refers to blockchains that operate on a "proof-of-stake" network. In Defi, staking is simply a way to encourage users to lock their asset up for the long term, instead of immediately selling them. Most protocols will usually share network revenues with stakers to keep them incentivized.

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You can currently stake ETH on Lido and earn 5% APR on the ETH that you deposit. This ETH will be delegated to validates that help uphold the network. As you reward you'll receive 5% ETH interest per year.

Liquidity provider

DEXs (decentralized exchanges) such as Uniswap, Pancakeswap, and Sushiswap are popular because of their AMM protocols (automated market makers). Instead of maintaining order books like traditional financial exchanges (or even centralized crypto exchanges) these DEXs have "pools" of token pairs ($1m of ETH and $1m of USDC).

These pools are public and anyone can provide liquidity to them. In exchange for depositing your tokens, you receive a LP token that represents your deposit. (You can redeem your LP tokens at any time and receive an equal number of the 2 tokens back).

As an LP, you earn a share of the swap fees or commission proportional to your share in the pool.

When providing liquidity it's important to be aware of impermanent loss that might occur is the tokens you pool fluctuate a lot in value. Impermanent loss is a bit more advanced than this guide is meant to cover but you should definitely learn about it before entering an LP position.

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You can provide liquidity on Quickswap to their USDC-MATIC pool. Let's say you deposit $500 worth of USDC (500 USDC) and $500 worth of Matic(~347 Matic). As you LP you would earn a 0.25% fee on all trades proportional to their share of the pool. Whenever someone swaps USDC for Matic or Matic for USDC, the pool take a 0.25% fee and those fees are split amongst liquidity providers based on the proportion of the pool that you deposited.

Yield farming

Yield farming allows you to earn additional income of top of the liquidity that you're providing. When you receive an LP token, you can lock these tokens up in "farms" that allow you to receive even more tokens (or platform tokens). Think of Yield farming as a combination of both LP-ing and staking.

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Building on the example right above, let's say we wanted to get additional rewards from our LP position on the USDC-Matic pool in Quickswap. You can deposit your LP tokens into a Farm on quickswap and receive QUICK, the Quickswap protocol governance token. Right now the Matic-USDC farm is paying 32.74% APY (paid in both more LP tokens and Quick tokens).