We’ve said this before: decentralisation is here to stay, and we better do our best to fit around it – whatever our level of involvement with the financial markets is.
Its advantages over the fallible classic models of centralised financial custody have been brought to the fore by the recent market shakedowns, providing its supporters with very clear negative examples to point to.
Undeniably, the next big thing on the horizon for the world of blockchain is its expansion beyond the realm of currency and tokenization – and into the broad landscape of Web3.
In the here and now, however, its immediate and most promising frontier remains the ever-evolving world of De(centralised)Fi(nance).
It doesn’t excite just because of its expansive community of innovators and because of the disruptive new paradigms it churns out at a prohibitive rate. It is also opening up tangible and approachable new pathways to revenue, some of which we’ll dig into below.
In many cases, these innovations can even provide a few different flavours of passive income – which was one of the main features making DeFi significantly appealing during the cash-rich period that followed the 2020 pandemic and accompanied the last crypto bull run.
Like anything left to simmer on its own, however, all the current decentralised financial products require a level of supervision, due diligence and risk assessment. After all, by very definition, the lack of a central authority figure combined with the unregulated nature of the crypto market of today means one’s actions are often as definitive as it gets.
It’s not all about the principles of financial self-regulation, collective responsibility and digital impartiality – the success of DeFi is also deeply rooted in its proverbial convenience and efficiency. Smart contracts have the power to automate slow and cumbersome accounting and administration tasks, whilst simultaneously reducing the resource needed to carry out the same functions via a human intermediary.
We’ll take a look below at some of the most prominent tools available to someone wanting to develop some passive income through DeFi solutions. Some of these tools can feel quite similar in scope and purpose at first, but their subtle nuances are both their strength and the reason why starting with educating oneself is the best approach here.
Staking
We’ve gone into detail on this one before, and it’s something we’ve got quite some expertise over here at RockX. It helps that it’s also the easiest tool on this list to explain.
Think of it as the savings account of the crypto world: a way to collect an annual percentage yield (APY) on the coins you already own – by depositing them in a bigger pool of money, such as you would do in your regular high-street bank. Except here, the returns are usually significantly higher and there is no centralised financial institution to regulate the pool.
Furthermore, your coins aren’t just sitting in the bank’s reserves or being lent out to other customers – they are acting as the very pillar of the financial system they’re a part of, by validating transactions and nodes for the blockchain they belong to. In doing so, they provide security and transparency to the rest of the network’s users – and get rewarded for their work through the staking commissions that make up the aforementioned APY.
Providing Liquidity
This is really similar to staking from certain points of view, and therefore best distinguished right away. As you guessed, it can also be a great passive revenue stream.
Just like those who focus on staking, liquidity providers lend their coins or tokens to a bigger pool – except here the aim of such a gathering isn’t security or network validation but rather exchange market facilitation.
The coins provided as liquidity form a ‘liquidity pool’ on a decentralised exchange, a platform used for swapping coins and tokens belonging to different ledgers. This makes their owners trade facilitators, and earns them a reward for their services.
Models like these are the basis of DeFi behemoths such as PancakeSwap or UniSwap. They allow enormous exchanges to operate with barely any human staff, leaving orders and trading services to be managed by custom-built algorithms.
It is important to mention that these are extremely complex financial organisms which are prone to serious dollar-value downsides during times of market instability. They should therefore be treated with care and only following scrupulous research.
A slightly different phenomenon is that of liquidity mining, which entails a double reward – not just in-kind through the very token liquidity is provided for, but also through a secondary ‘governance’ coin. The implications of this type of activity get rapidly complicated, but the top level is that this usually results in a larger degree of involvement in the decentralised project’s management from the liquidity miners in question.
Yield Farming
We did say these models had a lot of traits in common, and we weren’t kidding. Yield farming is indeed another way to access passive returns by partially relinquishing ownership of one’s funds.
This time, however, the funds temporarily shared with the network are locked in a decentralised application (DApp) through one or several smart contracts – and used actively as part of its operation.
The ‘yield farmers’ get rewarded for leaving their coins within the DApp for as long as possible, thus incentivising a good operative liquidity level to be maintained at all times.
Unlike liquidity mining, where the focus of the operation is the validation and protection of a specific blockchain, here the focus on the investor’s part is very much on the maximisation of financial upside.
Decentralised Lending
The final model of this piece is again not a new concept: whenever we deposit funds in our high street bank, they don’t actually sit idle in our account for very long (despite what the balance on screen might say). They are actually being used by the bank for other financial services it provides, chiefly lending to its customers.
DeFi lending does the same, except it cuts the middleman and connects the depositor directly with the debtor. And it has one other key advantage, just like most other cryptocurrency applications: transparency and accountability. This makes a full default on a debt pretty much impossible and takes a lot of the need for trust and honesty out of lending practices.
A Future Behind The Wheel
The quick rundown above comes quite clearly to one prominent conclusion: whatever the choices made by individuals in navigating the complex and multifaceted world of decentralised finance, the outcome will almost surely be a higher degree of ownership.
The elimination of the middle man doesn’t just reduce costs, reliance on manpower and human limitations such as dishonesty and malpractice. It also increases control and transparency, putting everyone keen to adopt decentralisation in the driving seat of their own financial future.
What’s there not to be excited about?
