deFIRE: Financial Independence Through Defi

This is simply a collection of the information I know today — I could be off-base on the finer details so please correct me in the comments if I’m wrong on anything below!

There’s a community I’ve been involved in for a long while — the FIRE community. FIRE stands for financial independence / retire early. The folks in this community recognize that life is much more than working until you die; what point is there to life if you can only enjoy it after you retire at 65 (optimistically)? Your youth is gone, and you’ve given your best years to the companies you’ve worked at to make outsized returns on your labor, in exchange for an underwhelming salary you simply survive on as the years pass by.

Depressing to think about. What the FIRE community looks to do is escape this rat race as early as possible. How? They do this by saving up as much money as they can and put it into income-producing assets and investments, so that once they hit a certain threshold, that income is enough to live off of — allowing them to retire early.

In early retirement, what might one do? That’s up to you to decide. The folks in the FIRE community who have “made it” actually have lengthy discussions on how living on a beach doing nothing forever actually is quite withering after a while, so they channel their energies into starting side projects, creating art, or doing stress-free “work” to stay sharp and engaged. But that’s not the topic of this post — definitely check out the FIRE community for that.

The Math

The core principle of FIRE is that your income-producing assets provide you enough to live off of, indefinitely. The first step to knowing how much income you need is to decide on your budget: do you need $1000 a month, $5000 a month, or $10000 a month? Some folks in the FIRE community decide they only need $1000 a month, and they move to a very affordable place to live in the world, like Southeast Asia or Central America. Others want to live the high life in expensive locales like New York City or Singapore. Knowing how much money you need a month is your starting point.

Then, you work backwards from there — how much income-producing assets do I need in order to generate that income? Many traditionalists in the FIRE community advocate for broad ETFs (exchange-traded funds) on the stock market, which average 7% returns each year.

However, you can’t just assume you’ll actually get an average of 7% returns on your assets year — you must take these two things into account (note: this is coming from a USA-centric point of view but the principles apply to you whatever your country is)…

Inflation

On average (prior to the crazy money-printing the US Treasury has done recently), inflation of the US dollar averaged 3% a year. So your true returns on that 7% would be 4%. If you don’t factor this in, the costs of goods will increase each year and your income will not keep up with it.

Taxes

There’s fundamentally two types of taxes that could affect you depending on what kind of assets are producing you income.

If your FIRE strategy is to simply buy, hold, and sell your assets at a higher price (which is what most of the FIRE community does with ETFs), that incurs capital gains tax. For capital gains taxes, if you hold the assets for more than a year before selling, you pay less taxes than you would if those assets were income (e.g. salary from a job). If you hold these assets for less than a year before selling, that is considered income and suffers from a higher tax rate. To add another nuance, tax rates for capital gains can also vary depending on what type of retirement account you are putting your money into (e.g. a 401k, Roth IRA, or some other) — detailing those is outside the scope of this post, but the FIRE community has some great resources on how to “hack” these for minimizing taxes due.

If your FIRE strategy revolves around receiving payouts of some kind, such as passive income or stock dividends, that money is taxed as income (a higher rate than capital gains taxes).

Remember that, in both cases, what tax bracket you land in is based off how much income you earn.

Putting it all together in an example

So assuming you want $5000 to spend a month, and assuming you’re using a capital gains strategy where you pay 20% in taxes, you will actually need $6250 pre-tax per month, which is $75000 per year. If your assets are gaining an average of 4% a year after inflation (7% minus 3%), you will need $75000 / 4% = $1,875,000 in total assets in order to FIRE.

Different flavors of FIRE

The above is just an example — you could decide you need more or less than $5000 a month to live off of; this is expressed in different subcategories of FIRE (there are more than these, but these are just a few examples):

• leanFIRE. You decide you need just a tiny amount of money (e.g. $1000 a month) to live humbly, but free.
• baristaFIRE. You want to quit your stressful job and instead take a lower-paying, less-stressful job to supplement your income. That income plus your assets lets you live the FIRE life.
• fatFIRE. You want to rake in a truckload of money and jet around the world in retirement, requiring you to make $20000+ a month from your assets.
• expatFIRE. You want to live elsewhere in the world to take advantage of the lower cost of living. You might have to pay a little extra for visas, but ultimately your quaint $2000 a month establishes you an upper-middle class life in that country. The added benefit is this: living as an expat overseas can cut the amount of taxes you normally would owe to the US government, which would reduce the total assets you need to have in order to generate your target income — something to think about!

What Defi (decentralized finance) does for FIRE

I like to think that the emergence of Defi will spawn a new flavor of FIRE: “deFIRE” — FIRE through Defi. Rather than using traditional financial instruments like ETFs to generate 7% returns a year, you can “reliably” make 10–20% returns yield farming in Defi, significantly reducing the total assets needed to achieve your FIRE goals.

One thing to note is that income from Defi is, at least in the USA, taxable at the same rate as income — despite you being “paid” in the form of digital assets, those assets are considered income. Nonetheless, you would make net more money even after paying a larger tax bill. Let’s take an example:

• You want $5000 a month to live off of. Because you’re being taxed at income rates and not long-term capital gains rates, let’s say you pay 35% tax. That means you’ll need around $7700 a month ($92400 a year) before taxes.
• Making 15% gains a year yield farming, we subtract 3% due to inflation (in reality this sadly is higher than 3%), leaving you with 12% yearly gains.
• You will thus need $92400 / 12% = $770,000 in total assets. Compare this to the non-Defi example where you’d need $1,875,000 to make the same monthly income!

Of course, putting $770,0000 dollars in a yield farm has its risks: you or the protocol could get hacked, the yield farm might see a sharp and indefinite drop in interest rates, you could experience impermanent loss (if you’re not using a stablecoin-to-stablecoin pool), or one of the underlying tokens you are providing liquidity to collapses and implodes. For this reason, it may be a good idea to spread your money across yield farms in many different pools and protocols, to mitigate this risk. Preserving your capital at all costs should be your primary objective — you might even want to take out decentralized insurance on these sums (be sure to factor that cost into your income calculations!).

My personal plan

Eventually one day, I would like to live overseas in a low cost-of-living country, where I pay less taxes to the US government than usual because I’m an expat. This gives me more money in my pocket after taxes, and that money goes further in terms of living costs. I’d aim for an upper-middle class lifestyle, and use my spare time to code up side projects to reinforce my financial stability with other streams of income, Digital Nomad style. I would plan on having enough money in Defi to accomplish this , and any additional wealth I have I would put into other diversified (non-crypto) income-producing assets such as real estate and stock market ETFs.

Let’s see if one day I can pull it off. Hopefully this post was informative and inspirational for you, especially if you’ve never before entertained the idea of FIRE, crypto, or “deFIRE”!

Disclaimer: This article is intended for informational and educational purposes only, and should not be considered financial advice. You should consult a financial professional before making any major financial decisions.