The DeFi space is renowned for its lucrative opportunities, offering innovative mechanisms that are completely new to the financial world. From staking to recursive lending, each strategy comes with its own rewards and risks. This article provides insight into these profit-generating strategies
Staking
Staking is the fundamental profit-generating strategy in DeFi. Simply put, this is the process of locking up the blockchain's native tokens to secure the network and validate transactions, earn rewards in the form of transaction fees, and issue additional tokens.
The rewards from the staking mechanism correspond to the activity of the network: the higher the transaction volume, the larger the reward. However, stakers must be aware of risks such as token devaluation and security vulnerabilities. While staking is generally a stable mechanism, it requires a clear understanding of the underlying blockchain's dynamics and potential risks.
For example, some protocols, like Cosmos, require a specific unlock period for stakers. This means that when users withdraw their assets from the staking system, they will not be able to actually move their assets for a period of 21 days. During this time, users are still subject to price fluctuations and cannot use their assets for other profit strategies.
Provide liquidity
Providing liquidity is another method to generate profits in DeFi. Liquidity providers (LPs) typically contribute equal values of two assets to a liquidity pool on decentralized exchanges (DEXs). LPs earn fees from each transaction made in the pool. Profits from this strategy depend on trading volume and fees.
High-volume pools can generate significant fees, but LPs must be aware of the risk of temporary loss, which occurs when asset values within the pool diverge. To mitigate this risk, investors can choose stable pools with highly correlated assets, ensuring more consistent returns.
It is also important to remember that the expected profit from this strategy depends directly on the total liquidity in the pool. In other words, when the liquidity of the pool is higher, the expected rewards become less.
Source: IntotheBlock
Loan
Lending protocols provide a simple yet effective method of generating profits. Users deposit assets, others can borrow those funds, of course paying interest. Interest rates change based on the supply and demand of the asset.
High loan demand increases profits for lenders, making this a lucrative option in bullish market conditions. However, lenders must consider liquidity risks and the possibility of default. Monitoring market conditions and using platforms with strong liquidity buffers can mitigate these risks.
Airdrop and point system
Protocols often use airdrops to distribute tokens to early adopters or those who meet specific criteria. In recent times, points systems have emerged as a new method of ensuring these airdrops reach actual users and contributors to a specific protocol. Specifically, users who make certain contributions will be rewarded with points and these points are correlated with a specific allocation rate in airdrops.
Performing swaps on DEXs, providing liquidity, borrowing funds, or even just using a dApp are all actions that often earn points. The point system provides transparency but is not a sure way to make a profit. For example, the recent Eigenlayer airdrop was limited to users from specific geographic regions and tokens were locked when the token generation event took place, causing controversy in the community.
Leverage in profit strategies
Leverage can be used in profit strategies such as staking and lending to optimize profits. While this increases profits, it also increases the complexity and risk of the strategy. Let's see how it works in a specific situation: lending.
Recursive lending leverages incentive models in DeFi lending protocols. It involves lending and borrowing the same asset multiple times to accumulate rewards provided by the platform, which greatly increases overall profits.
Here's how it works:
Asset Supply: Initially, an asset is offered to a lending protocol that offers a higher reward for providing compared to the costs associated with borrowing.
Borrow and resupply: The same asset is then borrowed and resupplied, creating a loop that increases the initial staked amount and the corresponding profit.
Earning: As each loop completes, additional governance tokens or other incentives are collected, increasing the total APY.
For example, on platforms like Moonwell, this strategy can convert a 1% offering APY into an effective APY of 6.5% once additional bonuses are integrated. However, this strategy comes with significant risks, such as interest rate fluctuations and liquidation risk, which require continuous monitoring and management. This makes strategies like these more suitable for institutional DeFi participants.
The future of DeFi & profit opportunities
Until 2023, DeFi and traditional finance (TradFi) operate as separate systems. However, rising Treasury yields in 2023 have accelerated demand for integration between DeFi and TradFi, leading to a wave of protocols entering the “real world asset (RWA)” space. Real-world assets primarily provide on-chain treasury yields, but new use cases are emerging that take advantage of blockchain's unique characteristics.
For example, on-chain assets like sDAI provide easier access to treasury yields. Large financial institutions such as BlackRock are also participating in the on-chain economy. Blackrock's BUIDL fund, which offers on-chain treasury yields, has accumulated more than $450 million in deposits within months of its launch. This suggests that the future of finance is likely to become increasingly on-chain, with centralized firms deciding whether to provide services on decentralized protocols or through permissioned pathways. like KYC or not.
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