Getting started with DeFi #4: Passive Income
One of the motivations behind getting involved in crypto for many is financial wealth. The dream is to earn money with little effort, and a promise of quick gains indeed has been drawing in speculative investors.
However, DeFi isn’t all just speculation. There are various ways investors can earn some additional money with their capital, depending on their affinity for risk. This post will cover passive income in the traditional sense and then passive income opportunities in the world of DeFi, including:
- Liquidity Mining & Yield Farming
- Running nodes
Let’s start with passive income in the traditional sense.
What is passive income?
When we work for a company and get paid for our efforts, that is known as active income. Active because we have to do something to obtain it.
On the other hand, passive income is income that requires minimal labor to earn and maintain. This might be a bit misleading because, in practice, to get to a point where you earn this effortlessly, you have to put some initial labor in, which then pays off over time.
Reasons to make passive income include having a backup plan, working towards financial independence, early retirement, or just sleeping better at night knowing that one isn’t dependent on keeping one’s job.
How can one make passive income traditionally?
Even before crypto, and the internet, people have found ways to make passive income. The most obvious one is investing. When investing, one buys shares, stocks, bonds and obtains passive income through their value appreciation, depending on the investment type also through dividends.
Buying a house to live in is one thing. Another thing is to use Real Estate for passive income. Instead of living in a flat/house yourself, you start renting it out, receiving a constant stream of income from your renters. Rental property can be a great way to generate passive income. But, in many countries across Europe for example, real estate prices are so high that with an average salary, one won’t be able to afford to buy a property to rent out.
Besides investing and real estate, individuals can also start earning money by renting out spare rooms (Airbnb), cars, and other unused items. Those with special knowledge in a niche can create online courses on platforms like Udemy and start earning from students buying these.
As you can see, all approaches to generating passive income require individuals to put some effort in before it pays off. What about earning passive income in DeFi?
Passive Income in DeFi
The most obvious way to generate passive income with crypto and DeFi is by imitating the traditional investing approach. Investing means putting money in with a longer time horizon than through simple trading and should be done after thorough research and secure storage of one’s funds on a cold wallet. Since we are not in the business of giving investment advice, and DeFi offers a lot more fascinating options to earn passive income, we won’t go deeper into it and instead focus on the following: Lending, Liquidity Mining, Yield Farming, Staking, and Running Nodes.
Probably the least ‘risky’ way to earn a reasonably steady income with your funds in DeFi is by adding your capital to a DeFi lending protocol. By providing funds, usually in the form of stablecoins, you will start earning interest paid for by borrowers who use the funds for their trading activity.
We have covered DeFi borrowing and lending mechanics in-depth in this post:
Getting started with DeFi #2: Borrowing and Lending
Before borrowing and lending in the crypto-economy, it's helpful to understand how things work in our current financial…
Depending on how comfortable you feel with DeFi and the idea of lending in general, there are also centralized regulated entities such as BlockFi or Celsius offering the same service with more holistic support.
The standard caveat when you involve a centralized intermediary is that you are not in control of the funds. Nevertheless, they might offer a more comfortable experience for someone completely new to the field.
Interest rates usually range from 5% to 12% on stablecoin lending protocols. For investors looking for higher yields (return on their assets), Liquidity Mining might be more attractive.
Liquidity describes the ability to buy and sell an asset without impacting its price quickly. In traditional markets, so-called market makers ensure that trading venues like exchanges have sufficient Liquidity.
In practice, this means that market makers will put buy and sell orders into the orderbook of exchanges. So to check how liquid an asset is, it’s helpful to look at the order book. A healthy order book contains orders at various price points and for different sizes that are similarly distributed across buy and sell-side.
Where does the Liquidity come from in DeFi? Liquidity Mining!
In DeFi, there are no intermediaries making markets. Instead, decentralized exchanges use automated market makers that define the price of asset swaps. You can find more on how these automated market makers work here.
Now to enable people to trade, we still need Liquidity.
Liquidity Mining is an innovative concept that makes trading smooth without sacrificing the ideals of DeFi. And not only that, but it also provides individuals with digital assets an opportunity to earn passive income. Liquidity on DEXs comes from individuals and institutions that provide their funds to the protocol to earn a share of the trading fees.
So if you want to make passive income in DeFi, one way is to mine Liquidity by adding your funds to so-called Liquidity Pools (pools where Liquidity from various people is aggregated).
You will have to supply two different assets that form a pair to the protocol on many protocols. So rather than just adding your Bitcoin, you might have to add UDST as well. Whenever someone trades the pool you are supplying to, you will get a small percentage of the trading fees.
On established platforms like Uniswap one can earn an APY (Annual Percentage Yield) of up to nearly 27% on some pools. Other platforms like SushiSwap and Bancor offer similar APYs.
Of course, that doesn’t take into account a potential decrease in the value of the assets you’ve provided.
So if a 27% yield isn’t enough for you, there’s yet another option out there, and it’s a risky one.
While some refer to Liquidity Mining and Yield Farming as the same thing, Yield Farming goes beyond just adding your funds to a liquidity pool in order to earn a share of trading fees.
A yield farmer will actively move funds across different platforms chasing the highest return on their investment. Instead of just looking to earn a share of the trading fee, yield farmers might also take into account potential airdrops of governance tokens of platforms.
Yield Farming is complex as it involves moving funds across DeFi platforms sometimes various times a week, to earn the highest returns possible. While it can be highly profitable it’s generally just recommended for advanced users or crypto whales.
If you followed the DeFi space closely over the last year, you might have come across protocols offering yields beyond 10,000%. In case you wonder how that is sustainable, it isn’t. Yield Farms with an APY that high are also referred to as Degen Farms. That’s because only the “degenerate” traders would use them. Despite their lack of sustainability in terms of reward mechanisms, they also pose another problem for investors: when to sell before it all comes crumbling down. That doesn’t take into account the risk that such high-yield farms might also decide to disappear with their investor’s funds as they did at Luna Yield.
It’s also worth mentioning that Yield Farming is a divisive topic with some thought leaders such as Vitalik Buterin, the founder of Ethereum, advising people to stay away from such projects. While the promise of quick money might lure new investors in, it’s questionable if the time spent developing such farms couldn’t be spent better on other use cases.
Lastly, a way to generate passive income in DeFi that doesn’t necessarily require a whole lot of funds is running nodes.
Isn’t running a node super complicated?
Not all nodes are created equal. Before starting to run a node, it’s essential to understand what kind of node you are running.
- Light Client: This is a client that only tracks your own transactions, and stores information that’s relevant to your history, but for every activity, it has to connect to a full node.
- Full nodes: These are nodes that store the entire ledger, and ensure that consensus rules are followed. Depending on the network, types of full nodes can include mining nodes (for PoW networks) and validating nodes (on PoS) networks.
- Pruned nodes: These are nodes that do not store the entire ledger, but only a part of it. A reason for that can be storage constraints. Blockchains like bitcoin require more than 300GB to store the entire transaction history. So if a node runner has only 10GB they can decide to store only the last 10GB of history.
On a Proof-of-Stake network, you might be able to run a node with fairly limited computing resources. However, it’ll often require an initial investment in the native token before you can actually earn any returns. Many Proof-of-Stake networks have minimum stake requirements well into the $10,000 worth of tokens.
On Proof-of-Work chains you will probably need to invest in specialized hardware to even stand a chance to make significant returns from mining as you compete with big mining pools.
Regardless of the consensus algorithm, many nodes will also require some familiarity with Linux and the command-line tool. Surely if we want to create a truly decentralized trustless network the ambition has to be making running a node easy.
Minimal Effort — Maximum Output
With Minima, you can run a node with minimal technical knowledge. All it takes to start earning your first Rewards is your mobile phone. Download and install the Minima app, follow the instructions — which include connecting to your Incentive account — and you are all set.
How much can I earn?
For every day that your node is connected to the Minima network, you are earning one Minima reward. To increase that, you can invite your friends with your invite code and earn 10% extra daily.
You might wonder, what the monetary value of these tokens is? Minima is currently in the test net. That means that we are still making changes, and testing the network before we release our final version of Minima.
To help us do that, we are rewarding early node runners through our Incentive Program. We can’t say what the value of one Minima reward will be at launch, as that would be pure speculation.
More than 20,000 people are already running nodes. Join them today.
Overall, there are various opportunities to make passive income ranging from less risky to highly risky. Some approaches require technical knowledge others require high initial capital investments. Minima is an easy way for anyone to dip their toes into the water with minimal effort required.
In the future, you will be able to use your Minima across a variety of truly decentralized apps.
When making investments in other platforms, don’t forget to do proper due diligence, and think about what events would change your timeframe of an investment, or even make you quit it entirely.
Emotions are strong when it comes to money. You might not be able to imagine how it will feel to see your initial investment down more than 50% in one day. That’s why it’s important to make a plan and invest only what you can afford to lose.
When investing and earning income with a plan with DeFi it’s a great experience. It’s the frontier. Join the evolution.