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Although I have most of my money in Bitcoin (BTC -0.15%), I still enjoy playing around with other cryptocurrencies. There is lots of potential to grow my portfolio by using DeFi, so I actively look for opportunities and take advantage of them. Over the course of the last two years, many DeFi applications have emerged, and with them have come strategies for generating returns. You just need to know what they are and how to use them.
Grow your money in DeFi
DeFi applications are like tools. The first step is to learn what tools are in your toolbox and how to use them properly. Like any tool, if you don't know how to use it, you risk getting hurt. Misuse can result in a total loss of funds.
The first tool in my toolbox is collateralized lending applications. Cryptocurrency can be locked in a smart contract and used as collateral to take out a loan. These are very risky applications, because if the value of the collateral falls too much, then the application will seize your collateral to cover your debt. However, if you are cautious and manage the amount of collateral you provide and the amount of debt you take on, then you can mitigate the risk. I prefer to take out no more than 50% of the value of my collateral. The interest on the debt accrues daily, and you can pay it off at any time without penalty.
You can loan most cryptocurrencies to DeFi applications with yield farms. These are applications that help decentralized exchanges run better. They do this by setting you, the lender, up with the borrower, the decentralized exchange. The exchange then uses the funds you've provided it with as liquidity for people making trades. When someone makes a trade, they pay a fee to the exchange. This fee is collected and distributed to the users who've loaned the exchange their money.
Anytime you provide liquidity to a yield farm, it is done so in pairs. That is, you must loan equal parts of two tokens. So if you want to provide liquidity to the BTC/USDT liquidity pool, you must provide $1000 worth of Bitcoin and $1000 worth of USD Tether (USDT 0.01%). This is risky because it exposes you to impermanent loss. Impermanent loss happens when the price of BTC changes with respect to USDT. Although you've deposited $1k worth of BTC and USDT, if you will withdraw from the pool, you would get more units of BTC if the price of BTC drops, and fewer units of BTC if the price has risen. The reason why it is called impermanent loss is because the loss does't actually occur until you've withdrawn. The reason why it is a loss is because in the case wherein Bitcoin rises and you get fewer units, you would have been better off just holding Bitcoin, and not depositing your funds into a liquidity pool.
There are ways of getting around impermanent loss though. If you loan money to the USDT/USDC pool, then there is no impermanent loss because the two tokens are stable with one another. So these are the types of liquidity pools that I prefer to loan money to.
This brings me to my preferred DeFi strategy to implement: I can collateralize my Bitcoin to take on debt in the form of USDT and USD Circle (USDC 0.11%). Then I can provide those stablecoins to a USDT/USDC liquidity pool. As long as the interest rate of the liquidity pool is higher than the cost of borrowing the stablecoins, this strategy makes money. The risk is relatively low, because even if the value of Bitcoin drops too low, I can always save myself by paying off my debt. This requires that I monitor the market for any sign of a sudden drop in price. Since I prefer to keep my stress low, if I see the value of my Bitcoin dropping against the amount of money I owe, I decide to pay down my debt. This involves withdrawing my USDT and USDC from the liquidity pool and paying off my debt on the platform on which I've borrowed it from.
The same kinds of DeFi applications exist on any smart contract-enabled blockchain, so you're not locked into using Ethereum. I prefer to use the DeFi applications on Cronos, a platform built by Crypto.com. Tectonic is the collateralized lending platform, and VVS finance is one of the yield farms. What is great about this strategy is that the applications you use don't have to be the ones I use. As long as the same functionality exists, you can go and find the applications on your platform of choice. Be careful to only use audited and publicly tested applications. Even then, DeFi applications are still subject to being hacked, which can result in a total loss of funds. You can make money by using DeFi applications, but you're doing so at your own risk.