Step by Step Guide on how to Earn Interest Lending with DeFi
Heard about the insane 20% interest rates some of us are earning on DeFi platforms such as Compound? Got FOMO and want to get in but overwhelmed with all the technical jargon? Well my friend you have come to the right place. I am going to outline in layman’s terms exactly step by step what you need to do to get started earning interest.
The article will be broken into 4 sections
- DeFi and Stable Coins Definitions
- How to Obtain Stable Coins
- The Step by Step Process
- Risks
Firstly there are 2 concepts you need to understand to start of with:
1. 1 DeFi
Decentralised Finance are applications which are built on top of a Blockchain. Even though the Blockchain itself is decentralised the DeFi app itself is not totally decentralised. Functions of the DeFi platform are created using Smart Contracts but there may still be centralised aspects to it. As time goes on and innovation in the space naturally occurs we will start to see more and more decentralisation. If you are reading this don’t worry you are still early to the party.
At a minimum when looking at a DeFi DApp it should be non-custodial. Meaning you should be able to deposit and withdraw your assets at any time without requiring approval. The platform should also be open to anyone, non discriminatory and may even allow for anonymity.
The most commonly used DeFi DApps currently out are:
- CompoundFinance offers Lending and Borrowing
- DyDx has Lending, Borrowing and Leverage Trading
- NUO Network has the widest assets to Margin Trade, Lend and Borrow. Also has unique model where interest is earned as borrowers repay loans.
- Fulcrum offers Lending, Borrowing and Leverage Trading
- Dharma focuses on UI/UX for ease of use
Together they represent over $400 Million USD locked for lending.
Each platform comes with their own risks and rewards.
1. 2 Stable Coins
Cryptocurrencies which are pegged 1:1 with USD. There is a central party which will hold the USD in reserves and in turn issue a token representing the value of $1 USD. The Stable Coin acts as an IOU and should be able to be redeemed back for USD. The issuer most likely will be a regulated financial entity in the US so you would be required to undergo AML/KYC for this.
Because they are regulated, the financial institution which mints the Stable Coin would be audited by a reputable third party such as a Big 4 accounting firm.
Popular Stable Coins used in DeFi:
- Dai (DAI) is created on MakerDAO by locking up Ether as collateral and creating a Collateralised Debt Position (CDP).
- USD Coin (USDC) is issued by Silicon Valley unicorn crypto exchange Coinbase
- True USD (TUSD) is issued by Trust Token
There are many others such as Tether (USDT), Pax (PAX) and Gemini Dollar (GUSD) but these are not currently used in DeFi DApps.
You have your traditional bank account with some fiat you would like to convert to a stable coin, now what do you do?
For DAI
- Create a CDP on MakerDAO and mint DAI if you have Ether cryptocurrency. The interest rate is pretty high to do this at 14.5% APR (7/09/2019).
- Trade crypto assets for DAI on big exchanges such as Coinbase and Bitfinex. A full list of others trading DAI can be found on https://coinmarketcap.com/currencies/dai/#markets
For USDC
- Use Coinbase and deposit USD into your account. Your USD is automatically converted to USDC.
- Trade crypto assets for USDC from exchanges. A full list can be found on https://coinmarketcap.com/currencies/usd-coin/#markets
For TUSD
- Sign up and create an account on TrustToken. TUSD is created when you send USD to them.
- Trade crypto assets for TUSD from exchanges. A full list can be found on https://coinmarketcap.com/currencies/trueusd/#markets
Now that you have decided on which Stable Coin you want to get you have some options on which DeFi platform to use.
- You will need a Wallet to store and interact with the DeFi DApp. For less complications I would suggest the one that is used across all the DeFi’s. Download the chrome extension Metamask.
- Once you have followed Metamask instructions to install the wallet you will have a public Ethereum address. A public address can only be accessed by a user who owns the private key. Transfer your holdings to this address. You can think of this address as your bank account and the private key as your password.
- Now choose a DeFi platform, preferably one which provides and maintains a high interest rate.
4. When you visit the website of the DeFi of choice you will need to connect Metamask to the DApp.
5. On the first time use you will also need to approve the DeFi Smart Contract to interact with the asset. Hitting enable will open up Metamask with the transaction details. You will need to pay a gas fee in Ether each time you interact with a Smart Contract.
Gas fees are annoying and expensive but will be significantly reduced in Ethereum 2.0
6. Once enabled, you are now able to supply your Stable Coin asset to start earning. Choose the amount you want to supply the protocol. Metamask will once again open and you will need to approve the transaction with associated gas fee.
Congratulations you have now joined and are participating in a whole new open financial revolution movement. Someone on the other end is borrowing your funds and it is being managed by computer code rather than a central party. Your interest is being earned in real time and will show up as each blockchain block is mined.
6. If anytime you want to stop lending you can withdraw your funds by accessing the withdraw functions. You are always in control of your funds.
Is DeFi too good to be true? There are some things you should consider before first deciding if you want to put your hard earned money in Smart Contracts.
- First of all there is a risk that there are bugs and vulnerabilities in the code that can be exploited. These risks are somewhat mitigated by 3rd party security firms such as Quantstamp auditing the smart contracts. With so much value locked up in DeFi there are huge incentives for hackers. That none of the DeFi’s have been hacked to date says something about the quality of the code.
- Liquidation risks causing socialised losses has been a thing on NUO. Low liquidity assets being used as collateral by borrowers could undergo a flash crash. With the Ethereum network being clogged at the same time the assets could not be liquidated fast enough by the platform. Leading to the outstanding loan not being able to be covered by the margin call forced sale. These issues have since been addressed with better risk management implemented. Important Note: There is a reason why NUO interest rates are a lot higher than Compound, DyDx and Fulcrum.
- Interest rate risks. The variability in rates vary greatly. When you see a rate of 20% APR it may not last and can quickly go to even 5%. Beware and keep your expectations on always high interest rates in check.
- Stable Coin unpeg. In the past there have been issues with the banking partner of stable coin issuer Tether. This caused the value of 1 USDT to fall to as low as $0.90 for short periods of time. You will need to have confidence that the financial institutions Coinbase and Trust Token will allow you to redeem USDC and TUSD for $1.
- Insurance from 3rd parties can be obtained on Smart Contracts if you are concerned funds can be hacked. Check out https://www.nexusmutual.io/ where you can get quotes.
With DeFi still in its infancy there are bound to be confusion on what opportunity it presents. You may already be financially literate but technology is not your area of expertise. Articles like mine are a starting point for your own research. Check out each DeFi to see which is suitable for you.
And a last piece of advice is don’t invest what you are not willing to lose.
Published at Mon, 09 Sep 2019 12:12:59 +0000
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