Welcome to this guide to earning passive income from your cryptocurrencies, created in partnership with Bitrue. You’ll get an introduction to the world of decentralized finance and two important ways you can earn an income from your crypto holdings. Let’s get started…
How blockchain underpins DeFi
How "proof of stake" supports blockchain
Taking staking to a new level
How to get started
1. Introduction to decentralized finance
One of the financial industry’s fastest-growing trends is decentralized finance, a.k.a DeFi. It’s a revolutionary way of transacting that doesn’t rely on centralized intermediaries like brokerages or banks for access to financial services.
The key technology powering DeFi is blockchain: a digital database of transactions – or a ledger – that’s distributed across an entire network of connected computers. That’s why a blockchain is often called a decentralized database: it’s independently stored on thousands of computers rather than being controlled by a single authority.
How blockchain works
Before we dig into how you can make money from DeFi, it’s important to be clear about how blockchain works. A blockchain is essentially a digital ledger of transactions that’s duplicated and distributed across a connected network of computers. Each “block” in the chain records a specific set of transactions, like a page in a physical ledger.
Every time a transaction takes place on the network, it’s first verified and then grouped with other transactions into a single block. That block is then added to the end of the chain (hence “blockchain”), and everyone’s version of the blockchain is updated. This collaborative system of recording transactions makes it very difficult to change or cheat the system.
And who verifies those transactions, groups them into blocks, and adds these to the blockchain? The thousands of people who’ve hooked their computers up to the relevant blockchain network.
But they don’t keep everything running smoothly for nothing: they’re encouraged to do so by the promise of financial rewards in the form of blockchain-native cryptocurrency. These incentives were originally distributed through a process called “mining”, but many blockchains are now moving towards something called “staking” instead – and that brings us to our first way of earning a passive income through cryptocurrency…
2. Introduction to staking
Staking aims to keep a blockchain network working as planned by incentivizing people to process transactions and update everyone’s blockchain accordingly. It’s based on a concept called proof-of-stake (PoS). Here, users lock up (or “stake”) their existing cryptocurrency coins for a period – and at certain intervals, the network randomly assigns one lucky staker the right to add (a.k.a. “forge”) the next block to the blockchain. The winner also gets a share of the network’s transaction fees in the form of some cryptocurrency – usually, the same sort as that staked.
Interestingly, then, staking both requires and results in an investment in the blockchain’s relevant cryptocurrency. And it’s kept secure because any would-be hacker would have to control more than 50% of the staked cryptocurrency.
How to stake
People who want to participate in a network’s staking process are required to lock in a certain amount of cryptocurrency. Generally speaking, the greater your stake, the greater your chances of being chosen to forge the next block in the chain – although other factors, such as token age, may be taken into account to ensure that the same big holders aren’t selected every time.
You can therefore use staking as a passive investment strategy, putting your existing cryptocurrency holdings to work in order to earn even more crypto. And doing so may well make sense: after all, why keep your assets idle when you could be both supporting a blockchain network and generating an income?
While you can stake directly yourself, the barriers to entry are pretty high. To stake on Ethereum once it moves to a PoS system, for instance, you’ll need to put up a minimum of 32 ether tokens, worth some $115,000 at the time of writing. You’ll also need to run special software – and run it continually, or else face penalties.
A much simpler way to stake involves going via cryptocurrency exchanges. Many popular exchanges allow you to stake a wide selection of cryptocurrencies with a much lower entry threshold. That’s because when you stake on an exchange, you’re basically contributing your coins to a wider pot called a staking pool. That pool stands a much better chance of raking in token rewards, which are then proportionally distributed among the pool’s contributors.
3. Start your passive investing journey with Bitrue
Bitrue makes it easy for you to be a passive cryptocurrency investor by managing the tricky technical aspects and security for you through its cryptocurrency accounts that behave like typical savings accounts.
4. Introduction to yield farming
Yield farming takes the concept of staking your cryptocurrencies to a new level. It’s riskier and more complicated than staking, which might be why it’s been dubbed “DeFi’s Wild West”.
Similar to staking pools, yield farming involves you contributing cryptocurrency to a liquidity pool which can then earn you additional crypto. That’s important because two of the most popular uses of DeFi today are crypto-based lending/borrowing platforms and decentralized cryptocurrency exchanges. In both cases, yield farmers provide liquidity: the crypto funds necessary for these platforms to function.
A decentralized cryptocurrency exchange, like your local foreign exchange broker, has to be ready to buy and sell a bunch of different currencies whenever a customer comes along – and in order to do so, it has to have all of these stocked in its drawers. That same sort of liquidity (only digital) is what allows a decentralized crypto exchange to act as an instant, automated market maker.
In the crypto exchange’s case, this liquidity is provided by yield farmers, who basically deposit their various cryptocurrencies with it. As a reward for doing so, the yield farmers get a cut of the exchange’s transaction fees in the form of additional crypto, often paid via “smart contracts”.
And DeFi lending platforms work just like your everyday bank, which takes in money in the form of customer deposits and then lends that money out to customers who want loans. Depositors provide the “bank” with the necessary crypto liquidity – and in return, they earn interest, again automated through smart contracts. The only thing missing is the physical bank itself.
Yield farming, it should be stressed, isn’t nearly as simple as staking. Yield farmers employ complicated strategies, constantly moving their crypto between different DeFi platforms in order to maximize returns. It’s the sort of game that’s only for very experienced blockchain users with a lot of money to deploy: yield farmers generally have to put down a large initial sum to generate any meaningful profit.
5. Choosing a provider
As you now know, there are a few ways to earn a passive income from your cryptocurrencies. They’re not all simple, though, and that’s why choosing the right service provider is of paramount importance.
You’ll no doubt want a provider that can support your earning income on a wide range of coins, and that can scour the market to offer you competitive yields. Who better, then, than a player with a long track record – one of the first to launch, in fact – and a provider who takes control over the technical and safety aspects of earning on your crypto, covering the entire value chain.
This guide was produced in partnership with Bitrue.