How to Earn Passive Income Using Decentralized finance (DeFi)

02 Feb 2021

In a world of ultra-low interest rates, traditional interest-bearing investments like bonds lose interest to fixed-income investors looking to see their holdings grow safely and steadily. Compounding interest can significantly boost an investor’s portfolio over time, but decent interest rates are necessary.

According to TheBalance, the average savings rate in bank accounts in the United States is currently 0.05%, while data from CNBC shows that on 30-year treasury bonds interest rates are currently 1.8%, while 5-year bonds yield 0.419%.

In the United Kingdom, 5-year bonds yield -0.034% and 30-year bonds yield less than 1%.In Germany, there’s no option in which investors aren’t paying the government to lend money. A solution for investors are applications built on the Decentralized Finance (DeFi) space.

These include decentralized exchanges, payments platforms, derivatives trading platforms, and lending platforms. On these lending platforms users deposit funds they wish to lend, which are collected into a pool.

Borrowers may draw funds from that pool to take out a loan. To take out a loan, borrowers will need to post collateral, and can never borrow funds worth more than the value of the collateral they post. A borrower may, for example, post collateral in ETH and take out a loan in the DAI stablecoin to avoid giving up on his ETH exposure while trading other cryptos, for example.

What You Need to Earn Interest on DeFi

Not a lot is needed to earn interest on your funds on DeFi platforms, other than the funds themselves. DeFi platforms can be accessed as any other website can, but to deposit the funds a cryptocurrency wallet compatible with them is necessary.

In this guide, we’ll use DeFi platforms on the Ethereum blockchain – where most of these platforms are built on – and as such we will need a wallet compatible with it. There are several wallets we can use, including MetaMask, TrustWallet, Opera and Brave’s built-in crypto wallet, and more. The examples given are available on both mobile and desktop.

Since we are using the Ethereum blockchain, we will need ether (ETH) to cover transaction fees. A transaction is necessary to both deposit and withdraw funds from these protocols. As they are decentralized, no know-your-.customer (KYC) or anti-money laundering (AML) checks are necessary and users can remain anonymous.

Earning Passive Income on DeFi

For this guide, we’ll be using Aave, the second-largest Defi protocol with over $3.8 billion worth of assets locked in it. Aave is only behind Maker, the protocol used to issue the decentralized stablecoin DAI.

We’re using the Brave browser with its built-in wallet, but any browser can use the MetaMask extension. Alternatively, using Trust Wallet or the Coinbase Wallet it’s possible to deposit funds to the protocol.

Once we access Aave’s website, we need to enter the app to access its functions. We’re given the option of using the first or second version of Aave, and we’re going with the newer version. After accessing, we’re prompted to give our wallet access to the website so these can interact.

After agreeing, we’re on the Aave markets landing page.

If we want to, for example, deposit DAI, we just have to click on the cryptocurrency’s page. Here, we’ll see historical APY data and the cryptocurrency’s utilization rate. For DAI, it’s above 7% and deposits have earned between 5% and 10% a year in interest.

After clicking on deposit, we’ll be taken to the deposit page, in which we’ll select how much DAI we’re looking to deposit.

After choosing our amount and clicking deposit, our wallet will trigger a popup asking us to confirm the transaction. Pay attention to the gas fee. Once the transaction is complete, our funds are now on Aave.

We can now choose whether we want to use the funds as collateral, in case we want to take out a loan, or not. It’s also possible to swap the deposited access for another on the platform to take advantage of different market conditions.

Most users, however, will likely just allow their funds to earn interest for them. Aave itself, is worth noting, is a system of smart contracts that enables the assets within them to be managed by a distributed network of computers running the software.

Users are not trusting Aave itself with the funds, and are instead trusting the code behind it and its execution.

Risks to Be Aware Of

While Aave has over $3.8 billion locked in it and has so far run smoothly, the same cannot be said for other DeFi protocols. If possible, avoid investing in unaudited protocols, and never invest more than what you can afford to lose, as the DeFi space is still new.

It’s important to point out that Aave or any other legitimate DeFi protocol will never ask you for your private keys or seed phrase. As a general rule, you should never give out that information as it could give others access to your funds.

Before moving your funds to a DeFi protocol, research the market to ensure you are as safe as you can be. Smart contract errors, volatility, price oracles, and other exploits have been used against smart contracts.

This is a sponsored story. Please remember that the value of investments, and any income from them, can fall as well as rise so you could get back less than you invest. If you are unsure of the suitability of your investment please seek advice.


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