The DeFi ecosystem has grown to about $80 billion in total locked value, according to DeFi Pulse. While that’s just a fraction of the traditional financial market, these protocols enable participants to generate above-market yields through lending and liquidity pools. As a result, investors may want to consider diversifying into the market.
Let’s look at how to get started with DeFi yield farming, along with some caveats to keep in mind.
Don’t forget to check our Fixed Income Channel to learn more about generating income in the current market conditions.
Getting Started
A MetaMask wallet is the easiest way to get started in the DeFi ecosystem with a browser extension or smartphone app.
After setting up a wallet, create an account at a cryptocurrency exchange like Coinbase or Binance. These exchanges make it easy to buy and sell cryptocurrencies without the technical complexity. You can quickly transfer tokens from these exchanges to your MetaMask wallet using the wallet address – although, you will be responsible for gas fees.
Most yield farming involves purchasing a particular cryptocurrency in your wallet, connecting the wallet to a DeFi platform, and then “staking” the cryptocurrency using smart contracts. For example, Uniswap enables you to connect your wallet and contribute to liquidity pools that support token swaps in exchange for a share of the fees the protocol charges.
Popular DeFi Platforms
More than 130 different DeFi protocols provide lending, decentralized trading, payments, derivatives, and other services.
The easiest way to get started with DeFi is using high-level managed services. You can think of these services as passive funds that conceal underlying complexity. For instance, Yearn Finance enables investors to deposit any token into capital pools that automatically generate yield based on emerging opportunities present in the market.
You can start using Yearn Finance by connecting your MetaMask wallet and depositing tokens into a vault. If you’re depositing ETH, make sure you have enough left in your wallet to pay the gas fees for future withdrawals. After a successful deposit, you’ll see the deposited balance in the vault interface along with the amount earned.
Risks To Keep In Mind
The DeFi ecosystem provides an opportunity to invest in cryptocurrencies and earn a yield, but there are some risks to keep in mind.
The most surprising risk is impermanent loss. Since DeFi pools calculate the price of tokens in a liquidity pool differently than the open market, high levels of volatility can cause some tokens to be worth less than their value on the open market. In some cases, you would have made more money holding the token in the open market versus investing in the pool.
Another risk that doesn’t affect conventional financial markets is technical risk. Since DeFi is built upon smart contracts, errors or vulnerabilities in those contracts can lead to losses. There are plenty of examples of DeFi protocols experiencing significant losses. And these losses are typically shared among the entire community in the form of a token devaluation.
Be sure to check our Portfolio Management Channel to learn more about different portfolio rebalancing strategies.
The Bottom Line
DeFi remains a fraction of the size of conventional financial markets, but there are opportunities to realize above-market yield. Investors interested in dipping their toes into DeFi’s waters may want to consider using MetaMask, Coinbase and Yearn Finance to build a passive income-generating strategy before diving into more complex areas.
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