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DeFi (Part 2)

The first and simplest mechanics for earning on the DeFi market is Staking or, in the context of the decentralized market, Yield Farming. The principles of these two phenomena are similar. Without going into technical details, it's similar to owning stocks and receiving dividends for it.

Staking/farming plays a crucial role in the development of DeFi. The demand is evidenced by the total amount of assets locked on decentralized platforms, which today amounts to nearly $40 billion.

Despite being a relatively progressive mechanism, staking is one of the most conservative forms of investment in the DeFi space. Investors earn income regardless of the token prices on the open market.

Staking is a passive earning method through long-term holding of cryptocurrency assets. In most cases, this process refers to the work of a validator in networks using the Proof-of-Stake (PoS) algorithm, which involves proving ownership stakes. In classical staking, rewards are paid directly by the blockchain for storing funds in the validator's smart contract. However, there is also a DeFi variant of staking called farming, where individuals or organizations borrow your coins for interest or use them to provide liquidity on decentralized exchanges.

Why would anyone pay for this?

Decentralized services do not have a single investor or beneficiary; they require contributions from private investors to carry out their activities. DeFi banks need them to issue loans, decentralized exchanges (DEX) need them to facilitate the exchange of cryptocurrencies without delays, and so on.

Stakers ensure the functionality of the blockchain or decentralized service without exerting any effort or spending time on it. So, the earnings here are genuinely passive without any catch.

How does such an algorithm work?

Users store their coins in the balances of smart contracts, and their assets support the processes running in the blockchain (PoS) or service (DeFi), and in return, the owners' balances receive regular rewards.

Let's take a closer look at the farming process:

  • Liquidity providers deposit a pair of cryptocurrencies (usually two) into a pool in an amount equivalent to dollar. From that point on, an automatic system consisting of a complex of smart contracts manages the funds.
  • A user who wants to exchange one currency for another submits a request to the pool. If there is liquidity in the pool, the user receives the desired tokens at a rate set by the smart contract, with a small fee deducted (usually a fraction of a percent). A portion of this fee goes to the liquidity providers.
  • When the volume of one currency in the pool decreases, the smart contract automatically increases its price and decreases the price of the other currency in the pair. This forms the market price.
  • A depositor can withdraw their funds from the pool along with the profits earned during their participation. However, withdrawal conditions may vary, allowing instant withdrawals in some cases or imposing withdrawal delays ranging from a few hours to several months.
  • When withdrawing funds, depositors may receive tokens in a different proportion due to changes in token prices relative to each other. However, the overall value of the initial deposit remains the same.

How to invest?

First, you need to find a suitable service, which can be done on one of the aggregators: DeFiLlama or DEX Screener.

Then, as an authorization step, you'll need to connect your wallet to any decentralized platform to start working. For Ethereum-based networks (Ethereum, Binance Smart Chain, Polygon, etc.), you can use wallets like MetaMask or Portis, while Tronlink is suitable for working on the TRON network.

After that, you'll need to follow the platform's instructions, which usually involve signing a pair of smart contracts and transferring funds using one of them. In practice, you need to click the "Sign" button in your crypto wallet attached to the website several times. After completing all the operations, your decentralized service balance will display your deposit and the amount of rewards received.

What are the risks?

An investor deposits multiple cryptocurrencies, and by the time they want to withdraw, the exchange rate between the tokens may have significantly changed. As a result, the investor will receive tokens in a different proportion. If the amount is significant, selling some unpopular tokens may become problematic.

In addition, DeFi protocols are occasionally targeted by hackers who exploit flaws and imperfections in smart contracts. Therefore, it is recommended to invest only in projects with technically competent teams that have undergone security audits by reputable companies.

This article is not an individual investment recommendation, and the financial instruments or operations mentioned may not align with your investment profile, goals, and expectations. The material is prepared for informational purposes and does not contain any calls to action or information that may be considered illegal at the time of publication.

Remember to conduct thorough analysis before buying and using any DeFi tokens.

© – , updated 08/07/2023
Reprints are allowed only with permission of BestChange

See also