Even though I have most of my money in Bitcoin ( BTC 0.48% ), I always like to play with other cryptocurrencies. There is a lot of potential to grow my portfolio using DeFi, so I am actively looking for opportunities and taking advantage of them. Over the past two years, many DeFi applications have sprung up, and with them have come strategies for generating returns. You just need to know what they are and how to use them.
Growth through DeFi apps
DeFi apps are like tools. The first step is to learn what tools are in your toolbox and how to use them properly. Like any tool, if you don’t know how to use it, you risk injuring yourself. Misuse may result in total loss of funds.
Guaranteed Loan Applications
The first tool in my toolbox is the Secured Loan Application. Cryptocurrency can be locked into a smart contract and used as collateral to take out a loan. These are very risky apps because if the collateral value drops too much, then the app will seize your collateral to cover your debt. However, if you are careful and manage the amount of collateral you provide and the amount of debt you take on, you can mitigate the risk. I prefer not to withdraw more than 50% of the value of my collateral. Interest on debt accrues daily and you can pay it off at any time without penalty.
Yield farming applications
You can lend most cryptocurrencies to DeFi applications with yield farms. These are apps that help decentralized exchanges work better. They do this by setting up you, the lender, with the borrower, the decentralized exchange. The exchange then uses the funds you provide to it as liquidity for people making trades. When someone makes an exchange, they pay a fee to the exchange. These fees are collected and distributed to users who have loaned their money to the exchange.
Whenever you provide liquidity to a yield farm, it is done in pairs. In other words, you must lend equal parts of two tokens. So if you want to provide liquidity to the BTC/USDT liquidity pool, you need to provide $1,000 of Bitcoin and $1,000 of USD Attached ( USDT 0.01% ). It’s risky because it exposes you to impermanent loss. An impermanent loss occurs when the price of BTC changes against USDT. Although you deposited $1,000 worth of BTC and USDT, if you withdraw from the pool, you will get more BTC units if the price of BTC goes down, and fewer BTC units if the price goes up . The reason it is called impermanent loss is that the loss does not occur until you withdraw. The reason this is a loss is that in the event Bitcoin goes up and you get fewer units, you would have been better off just holding Bitcoin and not depositing your funds into a liquidity pool.
There are, however, ways around impermanent loss. If you lend money to the USDT/USDC pool, there is no impermanent loss as both tokens are stable with each other. So those are the types of liquidity pools that I prefer to lend money to.
A synergistic DeFi strategy
This brings me to my favorite DeFi strategy to implement: I can collateralize my Bitcoin to get into debt in the form of USDT and USD Circle ( USDC -0.02% ). Then I can supply these stablecoins to a USDT/USDC liquidity pool. As long as the interest rate of the liquidity pool is higher than the cost of borrowing stablecoins, this strategy pays off. The risk is relatively low, because even if the value of Bitcoin drops too low, I can still save myself by paying off my debt. This requires me to watch the market for any signs of sudden price declines. Since I prefer to keep my stress low, if I see the value of my Bitcoin dropping relative to the amount of money I owe, I decide to pay off my debt. This involves withdrawing my USDT and USDC from the liquidity pool and repaying my debt on the platform I borrowed it from.
My Favorite DeFi Apps
The same kinds of DeFi applications exist on any smart contract-enabled blockchain, so you don’t have to use Ethereum. I prefer using DeFi apps on Cronos, a platform built by Crypto.com. Tectonic is the secured lending platform and VVS finance is one of the yield farms. The great thing about this strategy is that the apps you use don’t have to be the ones I use. As long as the same functionality exists, you can fetch the apps on any platform you want. Be sure to use only publicly audited and tested apps. Even then, DeFi apps are still susceptible to hacking, which can lead to a total loss of funds. You can make money using DeFi apps, but you do so at your own risk.
This article represents the opinion of the author, who may disagree with the “official” recommendation position of a high-end consulting service Motley Fool. We are heterogeneous! Challenging an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and wealthier.