Introduction
The finance industry has really undergone drastic changes over the years, most especially during the rise of cryptocurrencies and decentralized finance. With its increasing popularity, the way we think about money and investments has never been the same. In today's time, we're not solely relying on traditional financial systems since we slowly transitioned to the digital world, including how we can generate passive income.
In this guide, we'll explore three of the most common methods, how they work, and how it should be approached depending on your personal risk tolerance, level of experience, and long term financial goal.
DeFi Lending
Let's begin with lending. The process of earning a passive income with this method can be very straightforward and self-explanatory, but it does not mean it's easy and without risks. Furthermore, to do so, you can lend your crypto on decentralized platforms and in return you will earn interest. These platforms also allow users to provide liquidity by lending their assets and with smart contracts these transactions are automated and handled securely. Overall, the key to start earning passive income through lending is by choosing a reputable platform, weighing the risks, and deciding which assets are worth to lend. Also, it's essential to weigh both of its pros and cons, here's a closer look:
Pros:
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Lending, among all the methods, are generally considered as low risk.
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The process can be very simple, familiar, and easy to understand, making it best for beginners.
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There are numerous DeFi lending platforms to choose from that offer varying interest rates. You can select which fits your preference and goals.
Cons:
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The returns can be less significant compared to other methods.
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This may not appeal for those risk-seeking individuals as the process can be too simple and less engaging.
DeFi Staking
Another well-known method is DeFi staking where it's a strategy that allows users to lock up their cryptocurrencies in a decentralized finance protocol. The passive earnings are mainly in the form of rewards which can either be the same crypto that was locked up or a different altcoin. Staking, technically, is a process that enhances the security in a particular network, provides liquidity, and facilitates lending and borrowing opportunities. Thus, as a contributor, you will earn staking rewards that can be your passive income. Similar to lending, it has pros and cons.
Pros:
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It's moderately risky and offers considerable rewards that are great for passive income.
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This method encourages long-term investment and crypto holdings, allowing you to gain value appreciation in the long run.
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Aside from earning, it enables you to help secure blockchain networks which is also fulfilling.
Cons:
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Technically generates lower returns than yield farming.
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While locking up crypto holdings can be an advantage, it can also be a drawback as it limits liquidity.
DeFi Yield Farming
This can be quite similar with staking as this method also involves providing liquidity to the DeFi protocols in exchange for rewards as well that can be in numerous forms, compared to what staking offers, such as interests, trading fees, or governance tokens. Participants will be depositing their assets into liquidity pools on platforms that offer such opportunities. By doing so, they can start earning passive income that's based on the pool's transaction volume and reward structure. Most of the time, these yield farmers move funds between different pools to maximize their returns, referred to as crop rotation. Furthermore, while it has promising advantages, it also carries challenges.
Pros:
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Among other methods, it offers the highest return potential.
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It offers a diverse range of opportunities across many protocols.
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Participants can earn both yield and governance tokens.
Cons:
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It can be a high risk method due to smart contract issues and liquidity problems.
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Unlike lending, it requires complex strategies which can be an issue most especially for newcomers navigating the DeFi space.
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The process can be time consuming if you're not yet an expert of this strategy.
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The possibilities of impermanent loss is a huge risk.
Which Strategy Suits You Best?
While all these methods offer opportunities and advantages, not all suit different preference and financial goals. Thus, it's essential to assess and weigh the pros and cons before choosing a strategy.
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Lending - This is the best for beginners and for investors with low risk tolerance. While it offers moderate returns, it also requires minimal management with relatively low risks.
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Staking - This will only appeal for investors who are willing to lock their assets for a while. But if you're not in a rush and looking for moderate returns, staking is a great strategy and you can support blockchain networks too. However, it's important to understand The Risks of DeFi Lending before you commit your assets.
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Yield Farming - This method is best for experienced investors and for those who are comfortable with higher risks. But it's important to note that while it offers the highest returns, it requires significant expertise and active management in return.
Conclusion
All of these strategies offer great opportunities to earn passive income, but keep in mind that it also comes with risks. Thus, before choosing one, use this guide as your reference to engage with a strategy that aligns with your goals and risk tolerance.
