The DeFi ecosystem offers contemporary investors a wide range of different ways to make money. In fact, the number of available capital allocation options is so huge that the vast majority of newcomers usually feel overwhelmed and do not venture outside of their initial comfort zones. Beginners simply freeze and become so frightened to make a move that they simply miss out on valuable opportunities.
We will explore some of the most popular methods of creating passive income with crypto investments in the DeFi sector and provide multiple examples of effective capital allocation. Note that we do not endorse any of the projects mentioned below and encourage all our readers to do their own research to make informed investment decisions.
Decentralization brings to the table many advantages including self-custody, higher security, cheaper transactions, and the lack of any oversight leading to a democratic financial environment. One of the things universally loved by all crypto enthusiasts is the complete nullification of the counterparty risk thanks to the extensive use of smart contracts that automate many processes and eliminate the need for middlemen.
Investors do not need to work with brokers or trust unknown people with their assets. This freedom allows many to build uniquely composed portfolios with assets that come from the most distant corners of the DeFi ecosystem.
Let’s talk about some of the protocols that help you build a source of passive income by paying high interest rates, rewarding you with native tokens, or allowing you to earn by financing various investment operations or supporting blockchains.
In 2008, when Bitcoin started entering the public discourse, many early adopters did not think about the ways in which this new technology could change the world of finance. The introduction of Ethereum several years later created a new tsunami of projects that focused on swapping tokens, creating new services, and building an ecosystem that would reach a massive scale by 2022.
Initially, the Ethereum blockchain used the good old Proof-of-Work consensus mechanism that required immense computational resources and power to operate. By 2018, the community of developers decided to distance the network from the discussion about power consumption and laid out a plan to switch the consensus mechanism to Proof-of-Stake allowing stakeholders to become validators.
Today direct mainnet staking is offered by a variety of chains including Solana, Cardano, Avalanche, Arbitrum, Polygon, and many others. Below are some examples of staking setups that match APYs of US treasury bonds (4.11% in October 2024):
These are relatively tame options despite having the potential to beat all tradfi asset classes under certain circumstances. Staking is also considered a safe option that does not expose you to the same risk as some other investment approaches.
All protocols in the DeFi sector need liquidity to stay operational. DEXes and AMMs need it to facilitate swaps between different assets. Bridges — to send assets across the DeFi ecosystem. Other protocols to fulfill their functionality properly. Since there is limited liquidity in the sector, protocols have to compete against each other to secure their share. Offering generous APYs is one of the best methods for many DEXes to do so.
Paying more than is possible to generate through fee collection is an unsustainable business model. Instead, DEXes issue native tokens and pay interest using them. This process leads to high inflation and quick asset depreciation but many investors are willing to take the risk counting on their ability to time their exit correctly.
Below are some DEXes that pay well for liquidity provision:
Decentralized exchanges do have weaknesses and depend on the adoption rate of their native chains. For example, the future success of Aerodrome on Base will be determined by the performance of the network and its user activity metrics.
Lending protocols provide financing to other investors who want to switch positions without liquidating their assets. Since all loans must be overcollateralized, borrowing is limited to just 75% — 80% of the collateral’s value. It means that all lenders are protected and will earn regardless of the outcome. However, portfolios concentrated on these positions usually yield less and suffer from impermanent loss.
The increased safety of this investment approach drives up the growth of protocols like Aave, Compound, JustLend, and many others.
Take a look at some of the protocols in this category:
This particular concept is born out of the intense competition between DEXes. To secure the largest share of available liquidity possible, exchanges offer generous rewards and have to compensate portions of them with native tokens. Some of the options in this section of the DeFi ecosystem are very lucrative. Protocols like Aerodrome, Orca, and Balancer pay quite well.
Here are some of the platforms that you should check out:
Yield farming is one of the best approaches to investing in the DeFi sector if you can time your exit correctly. It is important to use technical analysis, impermanent loss calculators, and other analytical tools to have a good estimate of how much you can earn or lose under different scenarios. While high APYs may seem lucrative, understanding their origins and underlying assets is critical for the outcome of your investment activities.
First and foremost, you must understand that there is no perfect solution. For example, experts say that you should diversify investments and try to find a good balance by hedging against the most apparent risks. However, another group of financiers believes that concentrated portfolios perform better in the long run. There is evidence for both approaches.
Passive income can be achieved with a variety of instruments in the DeFi sector. You can choose to focus on one digital asset and simply have faith in its performance in the long term. You can also create a portfolio with dozens of positions. In some cases, using yield aggregators, automated strategies, like the ones offered by Rivo.xyz, and other tools can be a great solution.
Regardless of which general approach fits your preferences and risk style, you can follow several tips for choosing where to park your capital:
Remember that a good passive income strategy is all about consistency. You don’t need to have a 20% chance to receive a marginally better investment outcome. Instead, focus on building a portfolio that will perform well in the long term!
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