“Crypto assets as a class is moving from unproductive asset to a productive asset.” – Tim Ogilvie, Staked
DeFi (Decentralized Finance) or Open Finance, enabled by the programmable nature of crypto assets, captured the crypto world by storm in 2018 and continues to do so in 2019. There is a core difference of DeFi to fintech and traditional financial systems: In DeFi there is no bureaucratic or technological gatekeeper between the builder and their idea.
DeFi and associated technology enables token holders to capture the economic value from its changing productive nature. As of today, crypto-assets like Bitcoin are losing certain value as ~4% BTC is paid out to miners. The inflation is effectively diluting the circulating supply and existing token holdings while not generating passive income.
In this article, we would like to go over 7 major ways and a few special mentions of how to utilize the trend towards productive crypto assets. And finally, start receiving that sweet passive income.
Part I: Developed Opportunities
Unlike in Proof-of-Work, where the miners are the ones to capture the inflation rate via block rewards, in Proof-of-Stake token holders can expose their funds to certain (often very small) risk and earn rewards for doing so.
Note: You can also read our extensive report comparing PoW and PoS.
Currently around $12 billion has been locked in live PoS staking networks. With a shift of Ethereum to PoS, launch of Dfinity, Polkadot, Hedera, and other top-tier projects we can expect that to increase drastically.
The realization of interoperability leads to additional growth. Newer chains may choose to deploy on Cosmos or Polkadot. For example, Iris Network and Terra have chosen Cosmos as their interoperability hub. Going further we expect many more to go this path.
Getting deep insights into the individual returns for each asset we highly recommend browsing our website. The current average reward rate is 10.42%.
· In development: Near, Dfinity, Hedera
· “Old world” example: Starting a company, where you invest money, stand in with your name
Special mention: Masternodes
A masternode is a well-connected node with a set minimum (usually large) amount of collateral in coins. That must be exposed/staked in order to become a masternode. Masternode staking is usually paired with regular Proof-of-Stake or Proof-of-Work. There are several masternode hosting and shared masternode services like Gentarium and Gin. One has to be cautious with masternodes, as these mostly possess extremely high inflation, which leads to constant downward price pressure.
· “Old world” example: Poker Staking
2. Work Tokens (Resource Provision)
Work tokens represent a combination of staking aligned with the ability to perform work or provide resources to the network. Such work or resources can include transcoding, storage, data, and computational resources provision. A work or resource provider earns fees in the form of inflation rewards and/or fees in return for its work.
This creates a blockchain-powered marketplace connecting supply (transcoding, storage, data extraction, computation) with demand. Most of these have relatively high inflation rates as an incentive to bring supply to the network and accommodate future scaling.
Operating an Oracle (Trusted Interface), token holders can also earn rewards by acting as a trusted data provider. In this case, data acts as a resource being provided in a trusted fashion.
· In development): FOAM, Filecoin, Flyingcarpet
· “Old world example: Betting Bureau, Weather Stations, Yahoo Finance
Crypto asset lending usually takes place when a short seller or margin trader borrows funds for a relatively short period of time at a certain interest rate. There exist institutional off-chain lenders like Genesis Capital, which for now capture the most lending volume, representing however a counterparty risk. If one wants to lend or borrow in a trustless way, this is possible to do it on-chain via smart contracts using such protocols as Dharma, dYdX, etc.
Yields in a lending market can significantly fluctuate as they are heavily dependent on demand. Maker DAO has recently raised the stability fee in order to hold the DAI peg to USD. Interest is currently pretty high, sitting at 14% as demand for DAI is increasing. Mature and developed lending markets can help to maintain the collateralized stablecoin fiat peg.
Getting a deep insight into current lending interest rates we highly recommend checking out Messari’s Crypto Interest Rate Index. Current Rate is at 4.28%.
· Example: Dharma, dYdX, Compound, SALT, Genesis Capital, NEXO
· “Old world” example: Banks
Part II: Currently Underdeveloped Opportunities
4. Market Making Liquidity
Another crypto yield generating opportunity is the liquidity provision to market-making algorithms and liquidity pools.
Essentially, users act as market makers with returns heavily relying on trading volume and are dependent on price volatility.
Market Making returns typically fluctuate around 10% and is not as stable as Staking and Lending as it also has a higher price risk associated with it. Currently, around $40 million of assets act as productive capital in Market Making. Compared to the more developed yield-generating opportunities like Staking this is still pretty low.
· Example: Uniswap, Kyber Network
· “Old world” example: traditional market making
5. Payment Channels
Payment channels volume is pretty low today (~$6 million), but they might represent a large future opportunity. Bitcoin Lightning Network is the prominent example thereof. Payment channels are effectively a way to batch transactions, achieved by routing transactions through an intermediary node. This allows to reduce the number of total on-chain transactions by keeping track of BTC ownership claims within the channel. Bitcoin thus needs to be staked in lightning nodes in order to generate yield, which currently very low (<1%).
Currently the vast majority (99+%) of ~$6 billion paid in security fees to Bitcoin miners comes from block rewards and not from fees. In order to accommodate the shift from inflationary security model to fee-based model, the fees paid to miners need to increase significantly (100x by some estimates). This would greatly increase the amount of money going through the payment channels, impacting the yield.
Even Lightning Network Developers are convinced to design the system that operating nodes will just cover expenditures. We believe there will evolve actual profit models by staking Bitcoin or others.
· Example: Bitcoin Lightning Network
· “Old world” example: ?
6. Security Tokens
The universe of Security Tokens, Tokenized Securities, Equity Tokens and their distinctions deserve an article series on their own. This category of yield-generating crypto-assets is the closest to the off-chain traditional world. A token represents an asset or profit sharing claim and pays out dividends, returns on this asset and/or profits generated by it according to a certain time schedule. These are highly regulated, typically issued via an STO (Security Token Offering). Core infrastructure and regulations to acquire and trade these are still in development (Harbor, Polymath, tZero, etc.).
Depending on the underlying asset and its performance, the passive income can vary greatly. Missing infrastructure makes it hard to estimate today’s market volume. However when it goes live together with regulatory clarity, the potential market size of tokenizing assets can exceed tenth of trillions. Potentially every asset like e.g. stocks, bonds, derivatives and real estate can be tokenized.
· “Old world” example: Stocks, Real Estate
Special mention: Fixed Income Products
In comparison to the opportunities with dynamic reward rates (determined by network and market conditions, fixed income products are drawing more traditional investors into the game.
Stable, predictable and regulated yield-generating products are very attractive for them. One great example for such fixed income opportunity is the BitBond Token which guarantees 1% yield each quarter (4% p.a.). We believe this market is totally underdeveloped and it will grow significantly along with security tokens.
· Example: BitBond BB1 Shares
· “Old world” example: Fixed-Income Securities
7. Algorithmic Trading
One of the newest additions to DeFi space is Set Protocol with its product Token Sets. A Set is a token that represents a fully collateralized portfolio of other assets (BTC, ETH, DAI, etc.). Sets automatically rebalance the portfolio by executing a pre-programmed portfolio strategy (e.g. range bound trading). These tap into other DeFi products like DEXs and relayers.
Set is an alternative to trading bots as apart from having a commission, traditional bots can pose significant risks depending on where these are hosted, degree of transparency over the code, lack of audits, etc.
As with most existing DeFi products, the Set target market restricts its usage to retail customers. And as with all trading, especially of highly volatile assets like cryptocurrencies, Set offers no fixed expected return. This makes the Algorithmic Trading the most risky way to earn (if at all) passive income with crypto. Returns in form of crypto highly depend on the strategy chosen and market conditions and unlike with Staking cannot be guaranteed.
· Crypto Example: Set Protocol
· “Old world” example: trading bots, hedge funds
There is a certain popularity to the term HODL in crypto space, which represents deep conviction in the bright future of crypto assets. While sharing this conviction, we do believe that vast majority of people are doing an equivalent of stuffing crypto under the mattress (hardware wallet) disregarding the potential productive nature of their assets. We, as Staking Rewards, find that somewhat of a missed opportunity.
With emergence of DeFi, there are multiple ways how one can leverage crypto holdings and generate passive income with it. Believing in the bright future of your coin and holding it until next bubble comes? Sure, but what if you are not only increasing the fiat value of your portfolio, but also the number of tokens, in a (relatively) stress-free manner? Sounds like an interesting value proposition and this is our goal to provide you with the latest Staking and passive income stats and knowledge.
As we have seen with Work Tokens, Market Making Liquidity and Lending, the maturity of respective markets can help drive supply to the marketplaces, maintain the stablecoin peg and supporting systems in scaling (Lightning Network). This means that the passive income sources above are creating value not just for the token holders themselves, but for the ecosystems as a whole.
All of the aforementioned opportunities are just the beginning, and we are still pretty early in our journey. With DeFi and overall blockchain adoption growing at close to exponential rates we are seeing today, good luck Congressman Sherman “nipping crypto in the bud”!
About the Authors
Gleb (Glib) Dudka is a strategic thinker and research analyst. He has bootstrapped the blockchain validator operations of T-Systems (Deutsche Telekom) as the first enterprise player in the space. At Staking Rewards he is leading Content and Research / Development.
Mirko Schmiedl is the Co-Founder, CEO and Product Lead at Staking Rewards. He is researching Proof of Stake Networks and yield-bearing assets since 2013. Prior to Staking Rewards he has led a Bitcoin Mining Operation in Southeast Asia.