What is Defi and How to Generate Passive Income with DeFi

The inception of blockchain technology and cryptocurrencies have created a whole new financial system through the decentralized finance (DeFi) ecosystem. Today, investors can earn passive income in multiple ways with DeFi, in addition to trading, and the opportunities are only increasing. The total value locked in DeFi projects has increased significantly from 2021, and is presently valued at more than $200 billion as of April 2022. In this article, we review what DeFi is, and how it enables users to earn passive income in multiple ways.

What is DeFi?

DeFi is a new financial ecosystem developed through blockchain technology.

It enables financial activities such as lending, borrowing, transferring funds, earning interest, and buying insurance, but without central authorities and intermediaries. This results in low transaction fees and more efficient fund transfers.

DeFi offers multiple benefits when compared to the traditional financial system, including a low barrier for entry. Millions of people around the globe are unbanked and find it difficult to perform basic financial activities such as fund transfers.

With the help of decentralized finance, even unbanked individuals can access financial tools.

Additionally, DeFi provides multiple opportunities for users to earn passive income with their existing crypto holdings. With DeFi protocols, users can earn interest at a much higher rate than what might be possible in traditional banks.

When investors store or stake their crypto holdings on a DeFi protocol, the platform uses those funds as resources to validate transactions on a Proof-of-Stake blockchain network. As a result of these high-demand applications, and by reducing the fees charged by middlemen, DeFi can offer high reward opportunities for users.

3 Methods to earn passive income with DeFi

The development of the DeFi ecosystem has led to multiple passive income opportunities. The most popular passive income methods with DeFi are yield farming, staking, and lending.

Yield farming: Yield farming, also known as liquidity mining, allows investors to earn more crypto with their existing crypto holdings. In yield farming, investors deposit some of their crypto holdings in a smart contract-based liquidity pool. The deposited funds are then redistributed to other projects through DeFi protocols. Investors then earn rewards in exchange for depositing their crypto holdings. Investors who earn income through yield farming are called yield farmers.

Staking: Blockchain networks that work on the Proof-of-Stake consensus mechanism are becoming increasingly popular, which opens the door for staking. Similar to yield farming, the participants (also known as validators) stake their crypto holdings, validate transactions, and maintain the integrity of the network. In exchange for staking cryptocurrencies and validating transactions, participants earn rewards in the form of crypto. With the help of delegated proof-of-staking, investors can stake their cryptocurrencies in staking pools and earn passive income at regular intervals.

Lending: In this method, investors lend their cryptocurrencies on DeFi platforms. DeFi platforms allow users to perform financial activities like lending and borrowing funds. Certain DeFi platforms allow investors to choose their preferred interest rate and lending period, while some platforms have predefined interest rates and periods. Investors can also lend funds to liquidity pools or automated market-making platforms to earn high-interest rates. For depositing funds into a liquidity pool, users can earn passive income in the form of a portion of the transaction fees based on their share of crypto deposits.

DeFi Platforms to generate passive income

Let’s look at some of the best DeFi platforms to start generating passive income.

Aave (AAVE) - Aave platform is one of the most popular and leading DeFi platforms in the DeFi space.

To start using the Aave protocol, users need to deposit their preferred cryptocurrency and their preferred amount. Based on the amount investors deposit, users earn passive income based on market demand.

The platform even allows users to borrow funds by using the deposited amount as collateral. Additionally, it rewards users for staking the native token AAVE on the platform.

Synthetix (SNX) - Synthetix is a rapidly growing DeFi platform that allows users to mint their own synthetic assets, called ‘Synths’.

The platform enables users to trade cryptocurrencies for stocks, currencies, commodities, and other assets. Even though it runs on the Ethereum blockchain, the platform provides exposure to fiat currencies, derivatives, and other assets along with cryptocurrencies.

Users can bet on the price of an asset without actually holding the asset to earn income, which makes it the most prominent platform in DeFi.

Curve (CRV) - Curve Finance is a stablecoin and tokenized Bitcoin derivatives decentralized exchange platform.

Users can provide liquidity in the form of stablecoins to the Curve protocol and earn passive income from fees in exchange.

The fees generated by the transactions made on the platform will be rewarded to the users based on the deposited amount. Curve protocol also supplies pool tokens to other DeFi platforms such as Compound and Yearn.finance to earn interest and provide additional income to liquidity providers.

Bottom line

DeFi projects provide promising returns when compared to the interest earned in traditional systems. The DeFi space offers numerous methods to generate passive income and increase a trader’s present crypto holdings multifold.

However, users need to research the platforms and understand how they work before choosing a DeFi protocol and depositing their funds.