Where does money in DeFi come from?

Where does the money come from? How do we have liquidity in DeFi? Many of us might have heard that somewhere, somehow, there is that magical place in DeFi where you can just throw your money into, and it will be laying there brining you a nice income. Staking? Farming? What is it and how does it work? Egor Gavrilov, CTO and co-founder of xDAO, will answer those questions for us.

The right way to approach this is to, first, divide all DeFi projects into three main categories:

  • Decentralized Exchanges (DEX)
  • Lending Protocols
  • Yield Aggregators

The first category is Decentralized Exchanges (DEX). Everyone knows how centralized exchanges (CEX) like binance.com work. Binance.com is a huge bag of money and it tells you: ‘here is my money, come trade with it on my platform!’.

However, people already got tired of big bosses aggreagting the whole money, got tired of centralized control. And the creators of the first DEX, before creating it, saw, that there was a quickly growing trend for decentralization. So, they decided to adopt to this trend and they came up with the following: everyone would contribute their money to a joint pool so that people can trade in it. And they called it DEX. The money would still belong to depositors because they would have a certificate, proving that they contributed to the pool.

In order for people to invest in these pools, there has to be an incentive — commission. Hence, on decentralized exchanges, such as Uniswap, Panckeswap, and many others (that appear nearly every day), the payment from each transaction gets proportionally distributed among all liquidity providers.

The first way of making money in DeFi is to deposit money in Pools on the DEX so that other people can trade.

So, the first way of making money in DeFi is to deposit on the DEX so that other people can trade. This ‘profession’ is called a ‘Liquidity Provider’, and in return they get LP tokens. When people come in to DEX to swap their coins, ~0.3% from each transaction goes to LP Providers who contributed to this pool.

The second category is Lending Protocols. One might think that borrowing on DeFi is free money. If it is all anonymous, then you can just walk away without paying back. Not that easy. Lending Protocols are a bit more complicated than you might think, so you will be held liable without a doubt.
So how do these Lending Protocols work? Let’s review it with an example of a bank. You come to the bank and make a deposit for a fixed period of time; the bank uses your money to give out loans to other people, and you receive a very small portion of the profit from the paid interest. The same way it works in DeFi. You can borrow from a Lending Protocol, or deposit into it and make money from commissions paid by borrowers. The only difference is that the commission you get is a lot higher than the one you would get from the bank.

You can borrow from a Lending Protocol, or deposit into it and make money from commissions paid by borrowers

The third and the most interesting category of DeFi projects is Yield Aggregators. Let’s review AutoFarm, one of the Binance Smart Chain yield optimizers. AutoFarm summarizes all of the most known Decentralized Exchanges and Lending Protocols in one place, and lists their TVL (Total Value Locked) and APY (Annual Percentage Yield). One important thing to remember here, is that stated profitability isn’t fixed. It changes all the time, depending on the number of transactions per day that a particular pool has.

Through Yield Aggregators people can find the best DEX Pools at each moment of time, and move their investments accordingly. Thus, always maintaining the best profitability available.

For example, imagine today pool “A” gives you 0,08% of Daily APR (percentage rate) and 32% of APY (annual percentage yield). If tomorrow the number of transaction in this pool increases, it will give more APR and APY, because you will be paid more fees from this pool and vice versa.

Through Yield Aggregators like AutoFarm, people can find the best deals at each moment of time, and move their investments accordingly. Thus, always maintaining the best profitability available.
So, if you want to make a return on your money, and you are tired of low yields offered by traditional banking, xDAO suggests using Yield Aggregators to always stay on top and make consistently high returns.“

How to determine the best DeFi project nowadays?

TVL * Project Lifetime— a good DeFi protocol has the proper support in the community, and therefore a large amount of funds lying in there. It is also important that the project lasts for a while. It means that people have already tried to hack it several times, but they failed. This is a simple metric, but the most effective at the current time.

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