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Liquidity is one of the important things you have to look out for in a DeFi Platform. Also, there are decentralized exchanges and centralized exchanges. APR and the APY are the stuff investors should check.
APY refers to the Annual Percentage of Interest on the deposit made. APR refers to the Annual Percentage Rate.
The protocol should have strong integrations with oracle providers who are reliable and trustworthy. For instance, Chainlink, Avalanche, Pangolin, Efficient Frontier, Hummingbot, Aircoins, Blockchain Consilium, Peckshield, and Certik are some industry players.
Security and transparency are very important. The DeFi platforms that are audited are practically considered reliable to work with.
Defi helps with passive income in 4 ways: 1. Staking. 2. Become a Liquidity provider. 3. Yield farming. 4. Lending.
Staking is the process of locking cryptocurrency in a liquidity pool. In this process, the investor will be earning returns in the same token that has been invested with the smart contract. All blockchains which depend upon PoS are controlled by network validators. These validators sustain the consensus rules. Those validators who are dishonest are penalized, and they lose their stakes. Thus, stakers get rewarded for contributing to security and network decentralization. Thus, those who have staked in ETH will get rewarded in ETH.
Liquidity providers support the activities of decentralized exchanges like Uniswap and Sushiswap. The DEXs support is swapping between different token pairs. Tokens are pooled by liquidity providers to provide for the swapping process. Liquidity providers who stake in the smart contract liquidity pool will earn returns in proportion to their pool share.
Yield farming is the practice of staking and lending crypto assets to generate high returns or rewards. The rewards are in the form of cryptocurrency. Yield farming is risky due to the high volatility. With more investors adding money to the pool, the value of the returns decreases. Initially, stable coins were pooled, but now ETH pooling is very common.
Most of the yield farming protocols reward their users with governance tokens. These governance tokens can be traded in centralized and decentralized exchanges. Returns are calculated annually. APY refers to the rate of return gained during the course of a year on a particular investment. Compounding interest is computed regularly and applied to the amount, and is factored into the APY.
Both borrowers and lenders have significant risk to face in terms of yield farming.
