Can you make a living with DeFi?

Right folks, it seems like we have covered DEX basics in the first few articles and now it is time for fun. Can you really earn regularly with DeFi? Can it pay your bills so you can focus on whatever you prefer to do? Is it even legitimate to have a regular income without submitting applications and validating your identity?

The answer to all those questions is affirmative. Now, being cautious we should say that it all depends and blah blah.. having cleared this out we thought it is more important to say that the subject we are going to discuss here has little to do with investing in a token with seemingly high potential and wait till the price shoots up. This is called investing and requires ‘do your own research’ (DYOR) and due diligence and a hefty cake of luck.

The topic we are raising here relates to a sustainable way of earning regularly with little dependence on luck. This can be compared to a regular job — you do something and you get paid. If you’re looking for an advice how to make 60,000% gains within a month or even a year — we are sorry but this is not what you’ll find here. Current (it is important to use word ‘current’ and we’ll explain why later) DeFi landscape allows to employ your capital (sorry, you’ll need capital) at 50% and most likely more of annual return without needing luck. In fact, in DeFi too much of luck might play a bad joke on you in some cases. Thus better save it for something else.

So how do you earn with DEX? You lend your capital, assets, tokens and you get paid for that.

Very funny. How it is different from me lending money to a bank? The return rate. You see, Decentralised Finance is called like that because there is no Centre, there is no authority, i.e. middleman you need to pay for their services. Blockchain takes the role of the authority to validate things and the blockchain does not need a house, Lambo or Rolex and all this is left to you. We covered this subject in the previous article where we detailed the difference between DEX and CEX. So you can tap into what used to be the banks’ share. Heck, you become a private banker in a sense.

You can say that DeFi is the finance system fuelled by people that serves people. You can fuel it by providing liquidity if you have one. More about liquidity — what is it, why and how it is provided in DeFi — can be found here. Providing liquidity gives you an opportunity to earn from two sources:

• commission fee
• farming DEX tokens

Commission fee is usually 0.3% of the value of the trade made by people. Once you provided liquidity, your tokens now participate in all swaps made at DEX. Obviously the absolute amount of the income from commission depends of the amount of liquidity you provided. You contribution is added to the overall liquidity pool and 0.3% of the value of all trades is divided amount contributors based on their share. If you contribute 1,000 USD equivalent of tokens into multimillion pool then you should not expect significant income flow from commissions. Canary and other DEXes allow you to see your share that you are contributing during the process of adding liquidity to the pool so you know your stance.

Farming DEX tokens allows you to earn much more comparing to commission fees. All liquidity providers get Liquidity Pool tokens in exchange for the provided liquidity. In case of Canary these CRL tokens. This is a sort of visual proof of your share in the liquidity pool — they appear in your wallet. This amount of LP tokens represents your share in the pool. Each pool has its own unique number of LP tokens which is defined based on the size of pool. Each time someone adds liquidity to the pool, new LP tokens are minted — i.e. your and everyone else’s shares decrease. Every time someone removes liquidity — their LP tokens are burnt — i.e. your and everyone else’s shares increase.

The great thing is that you can stake your LP tokens. And boy this is where you get the most of return. DEXes fight for the liquidity and they attract liquidity providers by offering high returns on staking LP tokens. The range starts from as low as 15% in average and goes up to 400–500% APR depending on the pool and the strategy of a particular DEX. You can see the current APRs at Canary here.

Ok, APR stands for Annual Percentage Rate. This percentage shows how much return you will get for staking your LP tokens during a year. If you provide liquidity worth of 1,000 USD and stake LP tokens for 100% APR then it means that you will get 1,000 USD worth of return, i.e. you double your capital. Of course the above is true if the value of tokens remains the same and APR as well.

The thing with APR is that it changes over time. Each pool has an allocated reward amount (‘Pool rate’ in the example below) that is divided between all stakers of LP tokens based on their share of LP tokens. Obviously the more LP tokens of the same pool staked the less share of reward is per LP token. As soon as you stake your LP tokens in the farming pool you will see your reward in DEX tokens per week.

Thus you may want to check the APR in the pool from time to time to see if it remains attractive for you. In general we expect that APRs will be gradually decreasing as DeFi ecosystem gets more and more saturated.

Probably by now now you have few questions. Anyone?

Yes, thank you… well, you said that APR stands for annual percentage rate… does it mean I need to wait for a year?

No, you can provide liquidity and stake LP tokens at any point of time and withdraw your accumulated rewards or your LP tokens and provided liquidity anytime at Canary. No bonding periods. APR is a standardised way to show and compare yields across pools and give you an idea of how much you can earn. 200% of APR means you can double your initial capital in 6 months or earn half of it in 3 months (simple math) — again, provided all other conditions remain the same.

I heard APY is better than APR, why do not you give me APY instead of APR?

APY is not better or worse APR. APY is the way to calculate your return if you add your rewards to the original staking amount so in the next cycle of reward calculations the returns will be based on a slightly higher capital (compounded interest). APY stands for Annual Percentage Yield and it is another term for compounded interest. Imagine you staked 100 CRL tokens in the pool with 100% APR for a half of the year. In 6 months time you go to the pool and withdraw everything to get initial 100 CRL tokens back and 50 CRL worth of CNR tokens as a reward (100% APR /12 months * 6 months = 50%) thus ending up with 150 CRL worth of capital. This is simple interest accumulation.

If you bother to withdraw your reward everyday, exchange it into respective tokens, add them into the same pool and add new LP tokens to the staked ones then your capital will grow like this:

100% / 365 days = 0.274% per day

Day 1: 0.274% of 100 CRL = 0.274 CRL, you add 0.274 CRL to 100 CRL

Day 2: 0.274% of 100.274 CRL = 0.275 CRL, you add 0.275 to 100.274 CRL

Day 3: 0.274% of 100.549 = 0.276 CRL, you add… and so on.

So what you really do is this:

(100 CRL + 100 CRL x 0.274%) x 0.274%) x 0.274%) x …

you keep on multiplying by 0.274% 182 times (number of days in 6 months).

We can simplify the equation to calculate the compounded interest or APY:

100 CRL x (1+0.274%)¹⁸² = 164 CRL

You get 64 CRL tokens instead of 50 CRL. Thus APY in this case is 64% x 2 (for 12 months) = 128%. As you can see compounding rewards is more profitable. But you need to watch out for the gas fees. Luckily Avalanche offers quite low fees to pursue this approach. There are also pools that offer auto compounding, i.e. you do not need to claim rewards and go through all steps of adding liquidity, everything is done for you by the smart contract therefore you save on fees and hustle.

By the way, you can use this formula yourself to quickly understand APY based on APR and make comparisons of return rates in different pools if they use different approach to show expected rewards:

APY = (1 + APR/365 days)³⁶⁵

It’s all good but you get Impermanent Loss for providing liquidity, you cannot fool us!

Well, you are lucky because we happen to have an article about impermanent loss. But quickly — impermanent loss is the possibility to miss the gains from one token in the pair that significantly outgrows the other if you decide to withdraw liquidity exactly in this moment when such outgrowth happens. If you are after sustainable regular income recognising the opportunity to miss the spike in price then you should not worry much. In case you need to withdraw just wait till the moment when the prices of the tokens are in such positions when you can get back initial or close to initial distribution of tokens in the pair.

Also, there are incentivised pools with stable coins (USDT.e, DAI.e, USDC.e) where you are protected from IL. Stable coin does not change in price while if the other token in the pair grows — its amount diminishes but the amount of stable coins grows — i.e. you get less tokens but more stable coins (as if you sold your tokens for stable coins) in case you decide to withdraw. If the price of the token falls then you get more tokens in the pair and less stable coins — again if you withdraw now then you get more tokens than you provided initially which compensates the decrease of stable coins so the overall value of the liquidity in this pool remains relatively stable.

We hope you enjoyed the read and look forward to hearing more from us. We’ll make sure you do not wait too long. Stay tuned!

PS If you wish us to cover a specific question — please leave it in the comments below or ask it in the twitter with the hashtag #CanaryAcademy