Earning passive income from cryptocurrency in 2020: Market Review | Hacker Noon

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Blockchain enthusiast developer and writer. My telegram: ksshilov

While the lending market craze is plummeting and the “yield farming” opportunities are not as profitable as they were in the beginning, you might be looking for new ways to put your money at work.

In this article, I’m going to explore the best ways to leverage the current DeFi solutions for generating steady passive income at the lowest possible risk.

DeFi and passive income

Decentralized finance (DeFi) is the Ethereum ecosystem composed of financial DApps, smart contracts and protocols that are looking to revolutionize conventional banking by replacing its services with trustless code. The main idea is that without a middleman (the bank) the fees are much lower, no centralized authority has access to your funds, and everyone will be able to take advantage of these services regardless of where they leave. Today, we are already having decentralized exchanges, lending markets, tokenization platforms, prediction markets, payment networks, and many more to come.

Cryptocurrency is the perfect response to the current broken financial system. Anyway, things are not as different as you might think. DeFi gives you access to your tokens in the same way a bank is giving you access to conventional money. You can deposit, you can withdraw, you can spend them at your nearby store by using a payment card. And these services are extended to borrowing, lending, managing an investment portfolio. At the interaction level, today, there’s no big difference between a conventional financial system and a cryptocurrency-based one. 

Banks are usually offering interest on your deposit which makes it appealing to keep your savings into their account. The “deposit interest rate” model is not bad. The actual interest rate that banks are offering is. In most cases, the interest rate for deposit accounts is under 2% while the annual inflation of developed countries is more than that. In the US the inflation in 2019 was 2.3%. In 2020 it will be even more than that due to the current global pandemic situation. In other words, even if you are earning interest on your money, in the end, it is still worth less than the year before.

DeFi solutions are looking to take these working financial models and adjust them to the current reality: offer better interest rate, capital protection, and more investment options. Let’s find out what are the new decentralized services that you can take advantage of right now to transform your cryptocurrency savings into passive income generators!

Lend for tokens

Between “yield farming” and leveraged borrowing, the one solution you’ll see in the news is Compound. It’s a loan market where you can borrow and lend cryptocurrency without a middleman. Lenders are earning interest similar to a financial institution, while borrowers need to deposit cryptocurrency as collateral.

Similar services were available before. Anyway, Compound is not a peer-to-peer matchmaker. You are not borrowing directly from a lender. All the lent assets go into a common “liquidity pool” from which borrowers can access directly. That’s why the interest rate is not fixed, but dynamically set by an algorithm based on the demand. Interest which is collected from borrowers then split between lenders. The whole system makes it profitable for both parties, and particularly lenders which are looking for a steady passive income for their deposited amounts.

A steady income is nice. But Compound wanted to incentivize its users through its native token COMP. Anyone who would lend or borrow on their platform would also earn a small amount of COMP tokens. It was seen by the team as a great way to distribute their token. But, with the increased demand the token price kept rising, up to $250 a token. At this rate, the token returns are higher than the interest returns. When the token reached its peak, around 2,880 COMP tokens were issued a day. That’s $720,000 in cryptocurrency. What was supposed to be a passive earnings-generating platform became a get-rich grab.

However, that ended fast. Today, COMP price is less than $200 and the codebase was already updated. Under the new rules, users will earn COMP on the dollar value of assets they have put in or borrowed from the system. That’s much less than the initial rewards. But the initial purpose of the platform of offering their lenders a way of generating passive income is still there. If their interest rate is attractive to you, you can check it out.

Lend for interest

Lending capital on a lending market is a way to earn income and you should know that Compound is not the only one. And, without the high income from the bonus COMP, the interest rate is the most important variable. As mentioned on Compound platform the rate is dynamically adjusted by their internal algorithm. Sometimes you can earn more, sometimes you can earn less. What if you are looking for a more stable income?

Aave, or ETHLend, as it was previously called, is a similar platform which offers flexible rates. This platform mostly differentiates itself from its competitors through the vast range of DeFi collateral. It’s one of the oldest projects in the market, launched in 2017, and, now, in 2020 holds a significant market share in the cryptocurrency lending space.

There are many lending platforms and most of them are limiting their users to their fixed interest rates just to be able to promise higher income rates. Anyway, with fixed interest, if borrowing is getting too expensive borrowers will go away, leaving lenders with no earnings until the market cools down. Basically, when the market is doing good, you, as a lender, you’re doing less income than before. This leads us to the second option, variable interest rate as seen in Compound. It solves the initial problem, but it brings new problems. The high swings in the demand-supply ratio are now translated into the interest rate. Sometimes you are earning a good income, sometimes you are earning very little income. There is no predictability, making it an awful tool for generating passive income.

Aave changes it with a system where the lender can switch between the two types of interest rates. Depending on the market conditions you can choose a stable or a variable interest rate. This change made the platform very attractive and a real contender for passive income. Due to the stable rate usually being higher than the variable rate, the lenders are generally seeing higher returns.

However, both Aave and Compound are lending markets where lenders and borrowers are indeed able to generate income. But the returns are marginal and you are always forced to choose a side. When you are lending you are hoping that the price of your asset will go up. While, when you are borrowing, you are thinking that the price might go down. If the opposite is happening, not only that you won’t earn any income, but, in the case of borrowing, you might lose all your collateral.

This being said, always make sure you understand the position you are taking when making an investment, placing it in a structured deposit or lending it on a decentralized market. As Andreas Antonopoulos, blockchain educator said in one of his streams: “Passive income is when you put your capital to work, and that carries some risks […] An option is using a DeFi contract.” He even mentioned that he managed to “generate a side capital” from  DeFi platforms himself. As long as you are aware of the risks and you know how to manage them you might be sitting on the best way to put your money at work at the present time!
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Blockchain enthusiast developer and writer. My telegram: ksshilov


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