Staking DeFi Liquidity Pools and Lending- @pocketHs916
The world of cryptocurrencies evolves every day. Such as in any other market; trades sells, and buys is what occurs on the surface. Charting and technical analysis is exciting to predict price action, while fundamental analysis will help predict use-case and future utilities as problem-solving solutions in the world.
Trading cryptocurrency is how many investors enter the market. But what happens when one finds a token they want to hold on to? When one finds conviction in the project and decides to be a long-term holder? How can one maximize yields without losing exposure?
In this article, we will take a deeper dive into decentralized finance, in short, DeFi. DeFi is simply using blockchain technology for peer-to-peer transactions and using this to create your own finances or “bank”. Allow me to better explain this using the ecosystem and emphasis on this meaning.
Ecosystems rely on the cause and effects of each role within. From insects to mammals, to climate and land, an ecosystem is a chain of causes and effects. The same with a financial ecosystem and furthermore, with a decentralized financial ecosystem. Therefore, it’s important to identify an ecosystem and how it builds and maintains its resources and infrastructure. From these ecosystems, the emission of tokens is created or burned.
Each ecosystem is different, but in general, one will see different yield offerings by holding their tokens and being rewarded for this.
Let’s cover the top 3 strategies in DeFi.
The first and usually safest way to earn yields on your assets is by staking. What is staking? Staking is holding your assets in a protocol, and in return, you are rewarded. An analogy I have for this is:
I give you a dollar and ask you to hold it. Don’t spend it. And within a certain amount of time, I will give you a percentage of that dollar, or another reward, for holding it.
Many protocols will offer to stake, however, it is more than likely one will have the best yields and more security if staked on its native ecosystem. If you’d like more research on this topic, check out Vitalek Buterin’s article on “zones of sovereignty”.
The ecosystem might or might not offer a decentralized exchange for staking, also known as a DEX. ShibaSwap is SHIB’s main DEX and offers its native token, $BONE as a reward. $BONE is ShibaSwap’s governing token but also as important, used for gas fees for the upcoming Shibarium. $Bone is also not offered on many exchanges yet, which means this reward can be of substantially high gains if listed.
Staking $SHIB will gain $BONE rewards. And staking $bone will give you higher APR yields on $bone. As importantly, voting rights within ShibaSwap as it transitions into a DAO. Does this mean one is losing exposure to SHIB for $bone? Not quite considering the two are part of a three-token ecosystem in the Shiba Ecosystem.
Overall, staking offers yields and in some protocols voting rights. But only within its own native ecosystem.
- Providing Liquidity:
Providing liquidity is a higher risk play, but can be very rewarding. Liquidity is how value flows with buys and sells and the ease to convert to fiat because fiat is the most liquid asset; it’s easy to create the flow of value.
When providing liquidity into a pool, what one is doing is taking one valuable asset; a token, and pairing it with another asset, another token, or stable coins, and throwing it into a pool (a group of others). When someone wants to exchange or buy a token, the other asset is thrown into that pool and is distributed among those in the pool.
Impermanent Loss is important to understand in providing liquidity.
An example of impermanent loss is if pairing SHIB/USDC; if the value of SHIB goes up, it is paired with USDC at a stable $1.00, one would not gain as much profit if they were to have only held SHIB. However, if SHIB was to go down in price, pairing it with USDC would minimize that loss (just as well as minimize the gain mentioned above) with USDC being stable at $1.
If one was to predict two tokens are bullish, perhaps because they’re from the same cause and effects of their native ecosystem, then both tokens would grow in price action together (similar to the example above with SHIB and BONE).
Or, if one wanted to pair two tokens that contrast in price action, they could strategize and predict which token’s value goes up, causing more exposure to their paired token (meaning they have more of the less valued token and less of the token whose value went up). Depending on what one investor might want more of, an understanding of impermanent loss can be beneficial if used wisely.
However, research heavily before providing liquidity. It may not be the best avenue for one to accumulate a certain asset of one’s choice. Absolutely look into what you’re being rewarded with, and if you want that asset or not. Also, check what pools are rewarded with their own swap fees. Many DEXs offer high APRs on stablecoin pairs and that APR is mostly from the swaps between that asset and that stablecoin, keeping in mind the above mentioning of minimizing up and down profit.
Also, have a thorough understanding of what AMM (automated money-makers) and auto-compounding protocols are. These are smart contracts transactions, therefore it is up to you to know what is being transacted, with what, and what risks are involved.
- DeFi Lending:
DeFi Lending is a higher risk play but again, huge rewards. This past year cryptocurrency has seen financial institutional components enter decentralization. Many protocols work like “banks” or “financial institutions” and offer the rewards and responsibility of decentralization.
Some currently available protocols are Aave on the Ethereum mainnet, Anchor protocol on Terra Luna, and Abracadabra on Fantom and Avax. There are many!
Creating leverage on one’s asset is a little different in DeFi. Considering the market isn’t regulated and in certain countries, the regulations are not clear, many lending protocols and investors need a certain agreement to begin a smart contact interaction. Therefore, a large sum of colleterial is necessary.
Allow me to go on with an example:
I want to borrow against my eth to buy SHIB because I believe SHIB is going to have a run-up soon. I decide to go with Abracadabra and deposit $5,000 of eth as colleterial. I am able to set my leverage with my own risk tolerance. I can set the leverage at 25%(lower risk) to 60% (high risk). What this means is if Ethereum’s price hits 25% of its current price when setting leverage, my entire deposit of $5,000 will be liquidated. (if Ethereum is trading at approx. $4,000, I’d be liquidated if Ethereum hits $1,000. The same for the 60% leverage price; if Ethereum is trading between $4,000, I’d be liquidated if Ethereum hits $2,400) Depending on what leverage percentage, if what you lend as collateral hits that value, you will be liquidated of your entire deposit.
Now that one understands the penalties, let’s discuss what one is allowed to borrow. Most of these finance protocols allow 30% of the collateral. With the example of $5,000 I used above,
Abracadabra would allow me to borrow $1,500 of its stablecoin, MIM (magic internet money). MIM is a stablecoin that can be used on many blockchains and cross-chains such as Ethereum, Avax, Solona, Fantom. I will now take my $1,500 MIM and exchange it for SHIB. And I can do this on any exchange but I would personally use the route with the lowest gas fee.
And the strategies will differ here. One can take that SHIB and depending on the liquidation set price on their leveraged eth, can stake in ShibaSwap (very high risk considering the time lock in ShibaSwap) or trade on a high, return their MIM back to the initial Ethereum, and all those gains were from borrowed assets without losing exposure to the initial asset of Ethereum.
There are so many strategies. There are even strategies where one can borrow against a protocol, reinvest in that protocol, and borrow again, and reinvest, rinse, repeat, rinse, repeat until that borrowed value is too small to invest, but is a statistics on borrowing and lending and benefiting from this.
DeFi is a journey in itself. And it is crucial to stop and get your hands dirty. The ones who are stopping the car and not only taking a picture of the places traveled but learning the area and landscape, the developers and community will gain more understanding, therefore more control of their destination.
A few resources I use are DeFi lama and TVL. TVL is the Total Value Locked in each ecosystem. DeFi Lama is a great resource on the top 100 ecosystems and what projects are listed within that ecosystem.
And remember, love doesn’t make the world go round and round, but it makes the ride a lot more enjoyable.
Hope you enjoy the ride.
And that is DeFi, baby!
*This is a non-affiliate, contributing article written by: @pocketHs916