How are DeFi Protocols able to Pay Such High Yields?
Those who want their crypto to work for them will be able to generate highest returns by investing in DeFi. Typically, centralized finance happens through banks and bank related people. However, when it comes to centralized finance, investors and borrowers will have to depend on third parties to manage the entire process. However, when it comes to working with DeFi, there are no banks or bankers there are only liquidity pools which function as coded in the smart contract. Things are automated. Decentralized Finance because several members put their money in the liquidity pool – pooling of money.
The DeFi ecosystem permits users to lend, borrow, swap and stake their assets in a permissionless and trustless manner. Thus, the DeFi ecosystem works like a new Internet-native alternative to the traditional financial system. The Interest rates differ between protocols and it is common for users to be able to earn between 5% and 15% APY on their crypto holdings. In some cases, the rates can be much higher.
High Yield from Staking Happens
There are four types of yield that make up the foundation of all robust earnings in DeFi: 1. Staking Rewards. 2. Lending Rates 3. Exchange Rewards. 4. Fee Distributions.
- Staking Rewards: The security of the blockchain gets better when there are more stakers. Those who stake their cryptocurrency are known as stakers. Stakers will be able to earn rewards for securing the blockchain by contributing to the liquidity pool.
- Lending Rates: Lending rates refer to the borrowing rates. These rates are applicable for other people who borrow funds.
So, in a DeFi ecosystem, what typically one person deposits is taken in borrowing by another person and thus income is generated for the liquidity pool from which those who contributed to staking are given in return.
- Exchange Rewards: The third source of robust yield comes from exchange fee rewards. Liquidity pools which provide liquidity to decentralized exchanges, for instance like Sushi, will be able to earn exchange fee rewards. When exchanges have sufficient liquidity, users will swap between thousands of different tokens. Thus, exchanges will make an income and thus they will be able to pay the fee to the liquidity pools for offering them with liquidity. The return rates differ between decentralized exchanges. Most of the exchanges will have a page displaying the ROI for the liquidity supplied for the different trading pairs.
- Fee Distribution: Liquidity pools will provide the fee for users for choosing their platform. This will be in the form of rewards or tokens.
Thus, there are many ways in which users will be able to earn their returns as opposed to allowing the cryptocurrency to sleep or stay idle in wallets.
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