Dear Sunday Investors:
Welcome to our third week of the Sunday Investor! To our new members, the format of this weekly newsletter will be a deep-dive into one investment-topic. This week, we will continue our journey into ways that we can earn passive income through the power of decentralized finance.
Read, enjoy and share with your network. Let’s all build wealth together.
Recap of Last Week
Tracked by DeFi Pulse, the amount of USD flowing into the DeFi market has increased by over 600% in the last year. What we learned last week was how we, along with the early users in this graph can use platforms like Voyager, Celsius, and BlockFi to earn 8%+ on stablecoins and cryptocurrencies. This week we will go further into interacting with the DeFi protocols that power those returns.
What Do You Need to Get Started?
An account on a crypto exchange to buy Ethereum
An Ethereum wallet like MetaMask
Creating an account on a crypto exchange
First, you need to go onto a crypto exchange like Coinbase or Voyager and create an account if you do not have one. After your account is created, you will buy Ethereum.
Buying ETH is necessary as it is required to perform transactions on the Ethereum network. Without ETH, you will be unable to access the vast majority of DeFi or NFT products.
Setting up an Ethereum Wallet
Next, we will set up an Ethereum wallet like MetaMask. This will be your gateway to DeFi.
MetaMask is one of the most popular wallets and it can be download it here.
Next, download the appropriate version of MetaMask depending on the device you’re using and add as a Chrome browser extension.
Setup a new wallet clicking on “create wallet” and set a new wallet password.
Advice: Save & store your secret recovery phrase somewhere safe and secure. If you forget your password, this is the only way you will be able to access your account as there is no centralized organization that stores this information.
Don’t end up like this guy
Last thing you have to do is to withdraw the Ethereum you just bought from Coinbase (or another crypto exchange) to your MetaMask ETH wallet.
How to Do This:
Click on the “Send/Receive” button in your Coinbase (or another other crypto exchanges)
Copy and Paste your newly-created MetaMask ETH wallet address.
Confirm the transaction and wait for your ETH to send.
MetaMask supports all Ethereum-based assets (including stablecoins we talked about last week like USDC) so they can all be sent to your same Ethereum address on MetaMask.
Using a Decentralized Exchange
So now we have some ETH in our MetaMask wallet; what can we do with it? First things first, we can use Uniswap to swap our ETH to a stablecoin like USDC or DAI before lending and earning yields.
Go to https://uniswap.org/ and press “Launch App” to select which crypto asset you have, and which asset you want to swap to.
Verify the transaction in your MetaMask pop-up and ensure you are aware of the gas fees for swapping (think of gas as the cost of swapping/exchanging tokens on the ETH blockchain).
Uniswap is one of the best places to trade with any ERC-20 supported token. Example: You can trade ETH for wBTC. wBTC or Wrapped BTC is a token on the Ethereum blockchain that is 1:1 backed by BTC allowing for BTC exposure.
Pro Tip: Keep an eye out for slippage (difference in price from spot value) as it will vary depending on the asset’s liquidity.
How Does It Work? Uniswap depends on liquidity providers to supply assets to the protocol for other users to trade against. In return, these LP providers receive 0.3% of trading fees and stand to govern the protocol through UNI tokens.
Intro to DeFi Lending
Now that you have a stablecoin in your MetaMask wallet like USDC or DAI, you are able to directly interact with the top DeFi lending protocols like Compound Finance and Aave.
As we see from the graph above, the top three lending protocols currently have over 20B outstanding in loans across platforms. Let’s now walk through how this works and how we can lend our crypto assets to earn yield.
How Does DeFi Lending/Borrowing Work? You are able to lend your digital assets or stablecoins to a platform by locking your assets into a smart contract. Borrowers can then access these assets on Aave or Compound as loans and pay back interest to the platform. The magic coded into the smart contracts then distributes the interest accrued to lenders in proportion to what they lock in.
How To Use Aave to Lend Your Stablecoins:
Go to https://app.aave.com/ to enter the app. Once you do this you will be able to connect the MetaMask wallet you set up earlier by clicking “browser wallet” as seen in the picture below.
Next, you will be able to view the numerous lending and borrowing rates for each asset, and can select the asset you would like to supply to the lending market. In this case, we can choose the stablecoin DAI or USDC which will both earn us around 5% APY.
Click on “Deposit” and choose the amount of DAI you wish to deposit. The APY % changes day to day and you are able to see the historical rates on the chart (For DAI the APY has hovered between 3-9%). You will have to confirm the approval and deposit transaction in your MetaMask wallet as well as shown below:
To view your earnings for DAI in real-time you can click on “My Dashboard”
Both Aave and Compound are highly trusted DeFi protocols which support billions of dollars worth of volume. Aave has a more diverse pool of assets which you can borrow and lend with, while Compound has 8 assets supported and is more conservative with its onboarding strategy.
Notable Mention: Anchor Protocol works similarly to Aave and Compound and offers a 20% yield target on its algorithmic stablecoin UST, which is native to the LUNA blockchain. Something to check out and I can go into how to use the LUNA blockchain if this is of interest, comment below!
Associated Risks with DeFi Lending & Borrowing
It is very important to be aware of the types of risks when using any DeFi lending and borrowing protocols such as the ones mentioned above.
Technical Risks: There is always a risk of smart contract bugs/flaws which could allow hackers to exploit and drain collateral on a DeFi platform. It is worth mentioning that there are decentralized insurance protocols that you can use protect funds from this.
Collateral Risks: As a borrower, the main risk comes through possible mismanagement of collateral. If you borrow a loan from Aave with a cryptocurrency that has high volatility, if your collateral goes lower than the minimal collateral ratio on your loan it will liquidate your collateral. This is why it is vital to monitor all loans taken out as a borrower to ensure you have a healthy collateral ratio.
Week Ahead
There is much more we can dig into with decentralized finance and this series will continue later in this newsletter. But, next week we will go back into the realm of the stock market and trading in different types of investment accounts as we know that diversification is very important for our portfolios.
Comment below with what you want to see as a topic on an upcoming newsletter!
Not financial or tax advice. The content in this newsletter is for informational purposes only. Every investment and trading move involves risk. Do your own research when making a decision.