Introduction: The Concept of Passive Income in Crypto
The world of cryptocurrencyCryptocurrency A digital currency based on cryptographic technology to verify and secure its transactions and control the supply. A blockchain is used to store transactions transparently and verifiably. offers a multitude of opportunities for generating passive income. Among the most popular methods are stakingStaking The act of participating in a Proof of Stake network by locking up tokens as collateral to validate transactions and secure the network., lendingLending The act of lending cryptocurrency for interest., and liquidityLiquidity The ease with which an asset can be bought or sold without affecting its price. miningMining The process of validating transactions and securing a blockchain network through computational work.. These methods allow cryptocurrency holders, on paper, to earn income with minimal ongoing effort.
In this article, we will explore these three methods, providing concrete examples and comparison tools.
In general, it is advisable to avoid using intermediaries for staking or lending. Doing it yourself is not much more complicated, and using a third party adds additional risks (such as with FTX) and fees that can reduce profitability.
Disclaimer: It is important to be cautious with seemingly simple and easy methods, like passive income. Always educate yourself and form your own opinion, as no return is without risk. However, some solutions offer varying levels of return with more or less moderated risk (often, factors like effort and knowledge allow for maximizing gains while minimizing risks).
1. Staking
Staking involves locking a certain amount of cryptocurrency in a smart contractSmart Contract A self-executing contract with the terms directly written into code on a blockchain. to supportSupport A price level where buying pressure is expected to be strong enough to prevent further price declines. the operations of a blockchainBlockchain A public and immutable ledger of cryptographic transactions, organized in blocks. network, such as transaction validation.
In return, participants receive rewards in the form of new cryptocurrencies. This is essentially the result of new tokenToken A digital asset issued on a blockchain, representing various utilities, rights, or value. issuance (inflation), and if you don’t take advantage of it, you face dilution.
By helping to secure the network, you receive a reward. Generally, unless you become an independent validatorValidator A participant in a Proof of Stake network responsible for validating transactions and securing the network.A participant in a Proof of Stake network responsible for validating transactions and securing the network. yourself, you delegate your tokens to a validator who does it for you. In exchange, the validator takes a commission and gains more voting rights in blockchain decisions.
Risks:
- Losing staked assets due to slashingSlashing A penalty mechanism in Proof of Stake networks where a portion of a validator's staked tokens is taken away for malicious behavior or failure to perform their duties.: a penalty applied due to network or validator failures.
- Risk of staking with corrupt or deficient validators (or centralized platforms).
- Funds being locked up.
- If staking with a centralized actor, ensure it is actual staking and not another strategy (misleading use of the term “staking”).
Example:
- Ethereum: With the transition to Ethereum 2.0, ETH holders can stake their tokens to support the new Proof-of-Stake (PoS) consensusConsensus An agreement among blockchain participants on the validity of transactions. It is a key concept, essential for ensuring that all nodes on a chain share the same information. mechanism.
Currently, it is possible to earn about 3.7% annual percentage rate (APR, variable and not guaranteed, paid daily) on Lido for these ethers.
Lido is a well-known decentralized protocol. It offers ‘liquid staking,’ where the staking platform gives you a tokenized version of the tokens you deposit for staking. This allows you to avoid being locked in and use your staking as collateralCollateral Assets deposited as security to borrow other assets. Used to ensure that the borrower repays on time and avoids default. If the value of the collateral drops, the creditor may request additional collateral and sometimes issue a margin call. for borrowing. The downside is an additional risk of dappdApp An application built on a blockchain, operating autonomously without a central authority./smart contract hacks.
Comparison Tools:
Platforms like DeFiLlama, Staking Rewards, and Staking Crypto allow users to compare potential returns from different staking projects.
While cryptocurrencies like Ether, Atom, and Sol are popular for staking, stablecoins cannot be staked, only lent. This is where lending comes into play.
2. Lending
Lending allows cryptocurrency holders to lend their funds to other users or protocols in exchange for interest. This method is generally less risky than active trading and offers a more stable revenue stream.
Example:
- DeFiDeFi DeFi services use smart contracts, decentralized protocols, and tokens to offer a range of financial services that can sometimes replace those offered by banks, such as lending/borrowing, asset management, insurance, or asset exchange. Platforms: Platforms like Compound or Aave enable users to lend their cryptocurrencies and earn interest.
It is possible to set up ‘loop’ strategies where you lend, then borrow with what you’ve already borrowed, and re-lend, and so on. This is highly risky because, in case of de-pegging, you might face a cascade of liquidations and potentially lose your initial amount.
Given current lending rates (around 4%), which are lower than a 10-year US bond, I would be very cautious about the return relative to the risks. New products in Real World Assets might be worth exploring.
For cryptocurrencies other than stablecoins, lending may be more attractive than staking. Again, ensure the platform’s soliditySolidity The programming language used to write smart contracts on the Ethereum blockchain., whether centralized or decentralized (history, audits, liquidity, etc.).
Comparison Tools:
Sites like DefiLlama, DeFi Rate, and DeFi Pulse provide comparisons of interest rates across different DeFi platforms, along with quality ratings of projects (history, audit, size, liquidity, etc.).
Other alternatives for exploring DeFi: Alchemy Alternatives.
3. Liquidity Mining
Liquidity mining, also known as yield farmingYield Farming The practice of earning rewards by providing liquidity to a DeFi protocol., is a method where users provide liquidity to pools on decentralized exchange (DEXDEX A decentralized exchange platform without a central authority, often using AMMs to enable trades.) platforms and receive reward tokens in return.
To understand this, you may refer to articles on AMMAMM An algorithm used in decentralized trading platforms (DEX) to provide liquidity using pools. Liquidity providers deposit into these pools and receive a share of the fees generated by transactions. The algorithm determines the asset price based on supply and demand in the pool. and DEX.
In summary, you provide two tokens, which adds liquidity for people wanting to swap (buy or sell) in case there isn’t a buyer or seller in real time. In return for this liquidity provision, you receive a yield. Be cautious because depending on how the liquidity pool is set up, you may experience capital loss (impairment loss).
Example:
- Providing Liquidity: Contributing liquidity on DEXs like Uniswap or PancakeSwap and receiving LP tokens that can be staked to earn additional rewards.
Comparison Tools:
Platforms like Yield Farming Tools or DeFi Pulse allow users to track and compare returns from different liquidity pools.
Classic Cryptos and Stablecoins:
Just as with lending, stablecoins are often used in liquidity mining due to their stability, which helps avoid impairment loss. However, other tokens like ETH are also commonly used.
Conclusion
Staking, lending, and liquidity mining are three powerful methods for generating passive income in the cryptocurrency world. Each has its advantages and disadvantages, and it is crucial to research and understand the associated risks before committing.
