Money in the savings account is “dead money”. Because interest has long ceased to exist, in fact, a growing number of banks threaten negative interest rates above a certain amount. This is why investment advisors repeat the TINA principle like a mantra: “There is no alternative”, there is no alternative to stocks.
But this restriction on stocks is outdated thanks to blockchain technology. Decentralized finance, or DeFi for short, has already become a reality. DeFi is a collective term for financial services that are offered via blockchains, primarily Ethereum.
The collective term DeFi covers a large part of the scope of services of traditional banks: for example, earn interest, take out loans, lend money, trade in financial products and much more. DeFi offers a digital Wall Street alternative. Simply without the associated costs like bankers’ salaries.
Getting started with DeFi is relatively easy. All you need is a suitable wallet, such as MetaMask, and a device with internet access. DeFi projects and their associated DApp – decentralized application – such as Aave, Compound or MakerDAO can easily be used directly via the Internet browser, where you can select the desired application after connecting to your own wallet.
But there is still an easier way. Beginners who want to gradually approach the new world can get to know DeFi offers such as staking, lending or liquidity mining via the established crypto exchanges such as Coinbase or Binance. But what do these terms mean and what returns can investors expect? cash.ch presents an overview.
Staking – substitute for savings accounts
With staking, investors can make a certain coin – the “stake” – available to a pool for a certain period of time. The network uses the coins to find consensus or to validate new blocks – the newly stored transactions in the database. As a reward, new coins are paid out randomly and the coins or tokens increase – in principle, as you know it from the classic savings book or the overnight money account.
Only the interest rates paid are many times more attractive: this is currently a good 6 percent for Cordana or Solana. With Polkadot it is even more than 13 percent. And those who make their Etherum available for Etherum 2.0 will still receive more than 5 percent. How high the interest rates are in each case can be seen on sites such as Staking Rewards.
Staking is therefore a good opportunity for users who want to hold their coins for a longer period of time and who want to generate passive income on the side. But there are also risks with staking: The volatility of cryptocurrencies is usually very high. There are price gains, but in the worst case also big losses.
So-called stablecoins are a solution to this risk. These are crypto currencies such as Theter, USD Coin or Dai, which have a fixed exchange rate to a fiat currency such as the US dollar. However, it must be noted that most stablecoins are pure promises to pay on stored fiat money.
Lending – investors in the role of a bank
The largest DeFi protocols such as Aave, Compound or MakerDAO have one thing in common: their main application is based on lending and lending capital – the well-known principle from the classic banking sector. With lending, users make their own capital available to borrowers. So you give a loan. In return you get interest and can thus increase your own capital.
With crypto lending, however, you don’t lend fiat money such as euros or dollars, but crypto currencies. In addition, everything runs fully automatically in the blockchain. For this purpose, smart contracts – intelligent contracts – that also secure the lending business are used. Accordingly, there is no intermediary who wants to earn money from the credit business. This is also one of the reasons why crypto lending often offers significantly higher returns, especially when compared to traditional forms of investment.
Investors can find out about the current interest rates on sites such as DeFi Rate.
Liquidity mining – yield farming as a big promise
Liquidity mining is another way to generate rewards using cryptocurrencies. Investors invest their cryptocurrencies in so-called “liquidity pools”, which are implemented in the form of DApps on blockchains such as Ethereum. The capital in the liquidity pools is then available to credit platforms or decentralized exchanges, which fall back on it when they need liquidity.
In return, investors receive interest from the borrowers or they receive a portion of the transaction fees incurred in the form of tokens. Professionals then lend these tokens again to other liquidity pools and thus increase their returns even further. This is called “yield farming” in crypto slang.
The offered annual return quickly reaches 6 percent. The CoinMarketCap website provides a good overview. The returns are mostly dependent on timing. The users act opportunistically and look for the highest returns. As soon as there are no longer sufficient incentives, the capital often flows out again.
The greatest risk in liquidity mining lies in the “impermanent loss”. This quantifies a potential loss in value of the capital invested compared to simple storage in a wallet. Once this is high, it should decrease again over time – at least that’s the theory.
DeFi: Opportunities, but also risks
DeFi offers investors great opportunities – especially as a supplement to the savings book, but also to share investments. However, before large sums of capital are invested, these general risks should be considered: In addition to the currency risk mentioned, there are also technical risks that are significant.
The more advanced a smart contract used, the longer the source code. And the more complicated the source code, the greater the risk of errors. Likewise, the decentralized financial markets are not hacked to protect them. And as with any software, developers can act selfishly – manipulate the code “maliciously”. That is why it is important to select the respective DApp carefully and in an informed manner.