Decentralized Finance (DeFi) yield

Popular use cases and sources of yield

Feb 01, 2023
Decentralized finance, or DeFi for short, is a new financial system that is built on top of blockchain technology. It allows people to access financial services such as borrowing, lending, and trading without the need for traditional financial institutions like banks. Instead, these services are provided by smart contracts, which are self-executing contracts with the terms of the agreement between buyer and seller being directly written into lines of code. DeFi has the potential to revolutionize the financial industry by making financial services more accessible, transparent, and secure.

Use cases of DeFi

One of the main benefits of DeFi is the ability to access liquidity for crypto assets in a permissionless and instantaneous manner. This means that anyone can buy or sell their assets quickly and easily, without having to go through a centralized exchange or waiting for approval from a financial institution.
Another important use case for DeFi is token swapping, which allows users to buy and sell tokens in an efficient and seamless fashion. This can be done using decentralized exchanges (DEXs), which are run on smart contracts and allow users to trade directly with each other, rather than going through a centralized exchange.
Directional trading is another popular use case for DeFi. This involves executing a trade based on a specific view about a market's or asset's price direction, whether it is going up (longing) or going down (shorting). DeFi allows users to take advantage of market movements and make profits by buying or selling at the right time.
Borrowing and leverage trading are also popular use cases for DeFi. Users can borrow capital instantly and at an efficient rate to increase their exposure to a particular asset or market. This allows them to take larger positions and potentially make larger profits, but it also carries more risk as they are leveraging their capital.
Yield farming is another use case for DeFi, which involves deploying assets passively or productively in order to earn a return. This can be done by providing liquidity to decentralized exchanges, staking assets in order to earn rewards, or participating in other DeFi protocols that offer returns for providing certain services.
Staking is another way to earn a return in DeFi. This involves delegating capital to a project or validator with the expectation of receiving a portion of generated yields. Staking is often used in proof-of-stake (PoS) blockchain networks, where users can earn rewards for validating transactions and helping to secure the network.
DeFi also allows users to deposit capital into protocols and/or pools to generate a return as a liquidity (or counterparty liquidity) provider or lender. This can be a good way to earn passive income, as the deposited assets are used to provide liquidity or generate returns for other users.

Yield types

Yield refers to the percentage return you can expect to earn from investing capital in a certain way. There are two main types of capital, or principal, that you can invest: price-stable and price-fluctuating. Price-stable principal is a type of capital that does not change much in value and does not have much risk of losing value. Examples of price-stable principal are stablecoins like USDC, DAI, and USDT. Price-fluctuating principal is a type of capital that can change a lot in value and has more risk of losing value. Examples of price-fluctuating principal are cryptocurrencies like ETH and SOL. When you earn yield from an investment, you can calculate your total return by adding the change in the value of your principal to the yield you earned.
In DeFi, the yield you can earn and the risk of losing value in your principal can vary a lot depending on the specific investment you choose. Some investments may offer high yields but also have a higher risk of losing value in your principal, while others may offer lower yields but also have a lower risk of losing value in your principal.
There are two types of yields that can be earned in DeFi (decentralized finance): token-agnostic yields and token-specific yields. Token-agnostic yields are not tied to any specific project and involve an exchange of value between parties. Token-specific yields, on the other hand, must be issued directly by a project and contribute to the circulating supply of a token, potentially diluting the holdings of token holders. Token-specific yields are similar to marketing costs in traditional finance.

Token agnostic yields

One way to earn token-agnostic yields is by staking your tokens to help secure and moderate blockchain networks. You can also earn yields by lending out your tokens, or by providing tokens for others to trade or use. Another option is to take one side of a trade, like betting on whether an asset's price will go up or down, and earning money based on the outcome. These are just a few of the many ways you can earn token-agnostic yields in DeFi.
When you provide liquidity in DeFi, you're taking on the risk that the value of your assets could decrease. This is called "impermanent loss." Providing liquidity also means that you might miss out on potentially higher returns if one of the assets you're providing liquidity for goes up in value. On the other hand, lending is generally less risky, but the potential returns are also lower. There's also a risk of borrower default when you lend. However, lending is easier to predict and can be a good option for those who want a more stable, predictable return. Another risk to consider is that other investors or profitable parties might take some of your deposited assets. It's important to carefully weigh the risks and potential returns before deciding how to earn yields in DeFi.
The amount of money you can earn in DeFi depends on how much demand there is for certain services or assets. If lots of people want to use a particular service, you'll have the opportunity to earn higher yields. The way that you earn these yields is generally the same across different platforms. For example, the process for earning yields from overcollateralized lending is similar on different platforms. Yield rates are also usually similar across different platforms. You can earn yields in DeFi by directly providing capital or by holding a project token that gives you a share of the platform's earnings. These yields are typically earned over time, either through events like transactions or over longer periods like blocks. So if you're interested in earning yields in DeFi, consider the demand for different services and the potential returns.

Token specific yields

There are three main types of token-specific yields: token holder rewards, participatory rewards, and network staking emissions. Token holder rewards are offered to those who stake or hold a particular token, often in the form of rewards for participating in decentralized finance (DeFi) or governance-based projects. Participatory rewards, on the other hand, are offered to those who actively use a project in some way. Finally, network staking emissions are rewards offered to those who contribute to the proper functioning of the underlying blockchain infrastructure, such as layer 1 or web3 projects.
It's important to note that the returns on these yields can vary greatly depending on the specific project. The yield is only realized when it is sold to someone else, and there are many underlying assumptions that go into this process, such as the ability to sell on the open market and the overall health of the project. In some cases, token-specific yields can actually harm a project by diluting the value of the token or causing inflation, while in other cases they can help a project grow by increasing demand for the token.
Token-agnostic yields, on the other hand, are generally more predictable but have lower potential returns. These yields are not tied to a specific token or project, and as such they carry less risk. However, it is still important to be aware of the potential risks of token-specific yields, as seen with projects like Bancor where the yields can be very volatile. Ultimately, the best approach to investing in cryptocurrency is to carefully consider all of the available options and to do thorough research on any potential investments.