What happens when cryptocurrencies bring in interest?
Cryptocurrencies have long been proclaimed the future of finance, but it wasn’t until 2020 that they finally caught on to the old idea: making money with money. In the world of cryptocurrencies, decentralized finance (or DeFi) includes a wide range of blockchain-based applications designed to increase the income of cryptocurrency holders without relying on intermediaries – to generate the kind of passive profit that an investor can get from a savings account, treasury. bill or bond Apple Inc.
The idea seems to have caught fire, with DeFi app deposits surging from roughly $ 1 billion in June to just under $ 40 billion by the end of January 2021, suggesting that DeFi could become the mainstay of crypto from now on. In a tradition of disruptive innovation – as imagined by Clayton Christensen – DeFi could be the evolution of blockchain technology that could make it mainstream.
DeFi’s premise is simple: fix the long-standing inefficiency of cryptocurrency financing of capital dormant with non-zero opportunity cost. Now most investors buy cryptocurrency in the hope that the value of the currency itself will rise, as happened with bitcoin. Overall, this strategy worked great. Cryptocurrencies have risen in value so quickly that there was little reason to worry about a few percent returns here and there.
But the recent rise in stable coins, which are designed to maintain constant value, have changed that calculation. The aggregate market capitalization of stable coins like Terra and USDC more than quadrupled in 2020. DeFi is now opening up ample opportunities for passive income.
The attractiveness of a low-risk approach to cryptocurrency is obvious and can expand the pool of investors. For the first time, it is possible to receive compensation for ownership of cryptocurrencies (even in the absence of price increases), which provides real, tangible benefits for digital currencies and changes the description of an asset class, the only purpose of which was previously to sell at price. higher price. Consequently, many of today’s DeFi protocols may have the potential to become large and bold enough to compete with their centralized counterparts while remaining true to their decentralized roots. In addition, with the lack of volatility and the promise of more stable returns, institutional investors are now looking at cryptocurrency as part of their investment in alternatives.
Profitable farming and currency trading
The search for passive profitability of crypto assets, called growing crops, is already taking shape on a number of new lending platforms. Compound Labs has launched one of the largest lending platforms, DeFi, where users can now borrow and lend any cryptocurrency on a short-term basis at algorithmically determined rates. The Yield Prototype Farmer moves assets across pools to Compound, constantly chasing the pool, offering the highest annual percentage return (APY). In practice, this echoes the traditional finance strategy – the foreign exchange carry trade – where the trader seeks to borrow a currency with a lower interest rate and lend one that offers a higher return.
Growing cryptocurrency, however, offers more incentives. For example, by investing stable coins into a digital account, investors will be rewarded in at least two ways. First, they receive APY on their deposits. Second, and more importantly, certain protocols offer an additional subsidy in the form of a new token, in addition to the income it charges the borrower and pays the lender.