Are you looking to make money with decentralized finance? Decentralized finance (DeFi) is one of the most discussed topics in crypto and business today because it is changing the way we handle money. Much like other revolutionary blockchain-based innovations, there is massive earning potential from working with DeFi. However, it is a very new technology that is evolving rapidly. It is important to remember that DeFi markets and cryptocurrencies in general can be extremely volatile, so it’s important to be aware of the risks and invest carefully.
That said, let’s get into the basics of DeFi, various profit opportunities it offers, and the products which help you take advantage of them, including Pontem Blocks.
DeFi is short for decentralized finance. “Decentralized” refers to a financial system that exists outside of all-powerful controlling institutions. Think about the world of traditional finance: you are at the mercy of giant private entities such as banks, credit card companies, and lenders, as well as government institutions like central banks which control interest rates. These are all nodes of centralization, which is why many call traditional finance “CeFi”, or “centralized finance”.
DeFi as a term mostly refers to an ecosystem of blockchain-based financial tools. Blockchain is the infrastructure of choice for decentralized tools, because blockchains create inherently transparent ledgers of transactions. They can process payments without transmitting them through a powerful institution, such as a bank or clearinghouse.
Today, Ethereum is the most popular blockchain for DeFi tools. Other platforms like Avalanche, Solana, and Binance Smart Chain, and EOS are also commonly used. There are DeFi tools for just about every function of traditional finance:
To send, receive, and store cryptocurrency, a wallet is essential. You can think of it like your DeFi checking account. To use most DeFi tools, you will need to connect your wallet in order to access funds. This process is incredibly simple and automated by the wallet. The most popular wallets are MetaMask, Coinbase Wallet, and Kraken.
In traditional banking, the bank will loan your money to other customers and pay you interest in return for using it. However, these rates are often extremely low. At the moment, no bank is offering better than 1.00% annually, and most are even lower. Interest rates in DeFi are generally much higher, with some approaching 10% annually. Many centralized exchanges (CEX), such as Coinbase, Celsius, Gemini, Binance, and Kraken will pay interest on certain cryptocurrencies which you hold in an account with them.
The interest is earned because CEXs loan your holdings out to other customers, just like non-crypto banks do with fractional reserve banking. However, this transfers significant risk to the customer because there is no institutional backstop against default such as the FDIC, which insures bank deposits in the United States. If a centralized exchange collapsed, the customer would lose their crypto holding and likely have no recourse. The SEC went so far as to warn Coinbase that Lend, its interest-earning product, could face enforcement action.
An alternative is to use decentralized lending protocols like Compound and Aave, which is used by many decentralized applications (DApps) to determine interest rates. Right now, Compound has nearly $20 billion in assets earning interest across 16 markets and Aave currently holds $27 billion in assets. They both function similarly to traditional money markets by connecting borrowers and lenders. Interest rates are determined by the supply and demand for specific tokens. Users can borrow or lend crypto against collateral, and just as interest rates on savings tend to be higher in DeFI, so are the interest rates on loans. Compound and Aave are both over-collateralized, meaning they maintain enough cash on hand to cover potential losses. This lessens the risk involved as compared to CEXs, which are a single point of failure. However, there are always inherent risks, such as hacks or a crypto crash that affects the entire market.
With so many different cryptocurrencies and tokens available to use and invest in, it is crucial to have reliable, liquid markets for exchanging them. Fortunately, there are a number of different options here. The big exchanges like Coinbase, Gemini, Kraken, and Binance (which we already discussed because of their wallets and interest payments) all provide near-instant markets for a large number of cryptocurrencies. However, these exchanges are centralized. They charge fees for transactions, require you to submit personal information due to Know Your Client regulations, and are controlled by corporations, without democratic decision-making like DAOs.
A number of decentralized exchanges (DEX) have arisen over the years, which are quite large and reliable. They generally do not have extra charges beyond gas fees (a fluctuating usage fee for certain blockchain networks). They also tend to interface with more cryptocurrencies and tokens than the centralized exchanges. Ethereum-based Uniswap, Ethereum-based dYdX, and Binance-based PancakeSwap are three of the largest, each with billions of dollars in daily volume. Curve is also popular for exchanging stablecoins like USDC or Dai.
Everyone knows cryptocurrencies can be used for investing. However, the volatility which has made them famous also makes them rather risky compared to traditional securities. All of these different DeFi functions (exchanging, earning interest, lending) allows for more complex investment strategies which reduce risk. Several platforms exist which can optimize, or even automate, these combinations.
Yearn is a suite of DeFi products designed to optimize yield on platforms like Ethereum. Their first product, Earn, was a lending aggregator, which continuously monitored interest rates across Aave, dYdX, and Compound and moved money accordingly to maximize returns. Yield’s newest product, Vaults, goes one step beyond as a fully automated DeFi investment product. You choose a Vault, which is usually designed around a specific cryptocurrency, exchange, or both. Vaults do the rest, maximizing “yield through shifting capital, auto-compounding, and rebalancing.” To create a Vault, strategists develop and test their approach to earn approval from the Yearn team. These strategies enjoy double-digit APYs and you can withdraw at any time.
For those with more expertise who want more control over their investment strategy, platforms like Furucombo are perfect. Furucombo is a no-code DeFi automator which integrates with Uniswap, Sushiswap, Aave, Curve, Yearn, Compound and more. Simply select from a menu of different operations across those platforms to swap, borrow, deposit, or stake tokens. Linking operations into daisy chains allows you to maximize returns and Furucombo even shows you exactly how much you stand to have at the end. As long as your return is more than the gas fees (which can be quite high for several operations), you stand to make money on the transaction. Executing several actions in the same transaction saves on gas, which makes more trades profitable.
As you can probably tell, there are significant earning opportunities once you become proficient with DeFi. Let’s take a look at a few of those fundamental strategies. Many of these methods are employed by large funds and professional investors and remember: there is always risk with any investment.
Arbitrage means exploiting a difference in price between two markets to turn a profit. Here’s a simple example:
Al has a lemonade stand where he sells lemonade for $1 a cup. Ben wants to start his own lemonade stand and through his research, learns that his neighbors would be willing to pay $2 a cup. He realizes that if he buys Al’s lemonade, brings it over to his stand, and resells it for $2, he can make $1 in profit each cup with very little effort.
As you can see, arbitrage can be extremely lucrative. It has been used for thousands of years in all types of markets and professional arbitrageurs work in every market on Earth today. However, finding these price inefficiencies can be extremely challenging and time-consuming. Also, markets tend to resolve these inefficiencies fairly quickly, so arbitrageurs must work quickly in order to successfully exploit them for a profit.
For DeFi investors, exchange arbitrage can be extremely effective. Let’s imagine two new cryptocurrencies for this example: ACoin and BCoin. Now suppose Uniswap offers a rate of 1 ACoin to 2 BCoin. But on Sushiswap, the exchange rate is 1 ACoin to 3 BCoin. You could exchange 2 BCoin for 1 ACoin on Uniswap, then swap that 1 ACoin for 3 BCoin, resulting in a profit of 1BCoin. (Exchange rate differences are almost always much, much smaller and less obvious than that, but the principle remains the same.)
In the early days of DeFi, these inefficiencies could be extremely large and lucrative. Nowadays, because much more money flows through DeFi and many more eyes watch for these opportunities, they are generally much smaller and exist for very short windows. For that reason, many exchange arbitrageurs use bots to automatically scan for opportunities and exploit them instantly before they disappear. However, this requires a significant amount of coding skills, investment expertise, and a great degree of confidence and appetite for risk.
A similar strategy can be used to arbitrage between interest rates on savings and loans. Suppose a protocol is charging 4% interest per year to borrow ACoin. Then you realize that another protocol offers 5% interest per year for holding ACoin with them. You could borrow ACoin from one, deposit it in an account with the other, and pocket the 1 percentage point in difference as profit. You could also do this with two different tokens on the same protocol or with the same protocol on two different blockchains.
This approach can be challenging because of the small differentials involved. In order to make significant money, it often takes some time. It’s likely that the interest rates will be adjusted in order to correct the inefficiency within that period, rendering the trade unprofitable.
Normally, uncollateralized loans (lending money without money down or another way to ensure repayment) is quite risky. However, DeFi exchanges have come up with a clever way to reduce that risk using smart contracts known as flash loans.
Flash loans are extremely short-term loans encoded with smart contracts to ensure they are paid back. The code of the smart contract contains the loan itself, as well as the repayment. If the borrower’s wallet does not contain enough to pay the loan back almost instantly, the loan is not executed. These time spans are obviously incredibly short, but when combined with other actions, flash loans can be used to make trades and add leverage with minimal risk. Aave and dYdX are two of the most popular flash lenders.
Yield farming has become one of the most popular DeFi investment strategies. The term refers to the practice of optimizing your crypto holdings in order to generate the most interest. There are a number of variables that come into play: the DApps and exchanges used, the specific tokens held, the length of time held for, or selecting fixed (more stable) or variable (more upside) rates. Serious yield farmers check a massive range of different options. The best rates can often be found in exchanges between two small or obscure tokens. These are likely the most illiquid and rapidly fluctuating swaps, so the platform will use high interest rates to incentivize more users to stake their token and steady the market. A disciplined, focused investor can use yield farming to generate lucrative passive income.
As you can see, there are myriad ways to earn money in decentralized finance. The entire space has grown exponentially, with millions of users and huge amounts of cash in play. But as the space has become more crowded, it has also gotten more difficult to find a profitable niche, especially when your competition is massive institutional investors.
For that reason, many turn to automation to make their lives less stressful and generate more consistent returns. For the tech-savvy, using a DeFi bot or even coding your own is an effective option. However, that option is not available to most and remember: your bot will only be as good an investor as you code it to be.
Yearn Vaults are much more accessible alternatives which automate the process for you. Simply choose your preferred strategy, and the rest is taken care of. Similar to an Exchange-Traded Fund or investing with a fund, your money can be withdrawn at any time.
Another option is creating your own strategies with a no-code tool, like Furucombo or DeFi Saver. Simply drag and drop the operations you want to perform, and they automatically tell you how much you would make or lose and execute the trades for you. This is a great option for those with some DeFi knowledge or a specific idea, but who lack the technical expertise to code a bot. It also saves you time compared to doing multiple operations manually, which can mean the difference between a profitable or losing trade.
Pontem Network is the premier experimentation platform for building with Diem, the permissioned blockchain backed by Meta. One of our flagship products, Pontem Blocks, is our no-code, drag-and-drop system that allows you to combine various DeFi operations. It’s similar to Furucombo or DeFi Saver in this way. Be sure to check out our public prototype here.
The killer app of Pontem Blocks is that it integrates with Diem. We believe Diem’s relationship to Meta will help introduce 3 billion Facebook, Instagram, and Whatsapp users to the world of DeFi. We also very much believe in Diem’s ambitions to connect the world’s unbanked people with financial tools.
In addition, Pontem Network integrates the basic suite of DeFi tools with Kusama and Polkadot on parachains. The addition of new outlets will create huge arbitrage opportunities. Down the road, we expect to bridge permissionless blockchains with the permissioned Diem ecosystem. This will unlock a whole new world of DeFi investment strategies.