Cryptocurrencies
Earn Passive Income on Your Crypto Assets on Polygon
A primer on utilizing Defi and liquidity mining
If you don’t find a way to make money when you sleep, you will work until you die — Warren Buffet
Although cryptocurrencies have shown a tremendous rise in price action over the turn of the year 2021, adoption has still not reached its zenith.
As a result, knowledge about wealth creation in the crypto space is still lacking.
For the layperson, investing in cryptocurrencies is akin to playing with fire. Because of high volatility, the chances of making huge losses from investments are highly plausible.
However, what if there were a way to make money in crypto in a much more risk-averse environment?
Instead of “buying dips” and “HODLing”, what if one just dumped a portion of their investments into a platform and generated income regardless of market movements?
This article will look at how to leverage decentralized finance (DeFi) to generate passive income on our cryptocurrencies.
Disclaimers 🙅
- I am a data scientist and a machine learning engineer by profession, an economist and a statistician by education, and an amateur crypto investor, but I’m not your financial advisor. Hence, none of the opinions and ideas discussed in this article should be considered financial advice.
- There are a number of approximations taken into consideration when computing interest and rewards. In real life, interest rates are known to fluctuate over time.
Defi Lending Platforms 💸
Defi or decentralized finance is a method of finance built on top of blockchain technology. These platforms provide users with financial instruments in a trustless manner.
Instead of relying on central financial institutions like banks and brokerages, Defi platforms utilize smart contracts which supplant these central authorities.
Defi has gained significant momentum since the end of 2020.
As you can see, the total value locked (USD) in lending protocols and total Defi is $31.4 Billion and $57.2 Billion respectively.
Ethereum’s scaling concerns 😓
Until recently, the accessibility for these DeFi platforms was restricted to high-net-worth individuals due to the excessive transaction fees.
More often than not, the gas fees or the transaction fees on Ethereum are so high that users end up paying more money for transactions than for the amount of money being transferred itself.
Although Ethereum is working on a scaling solution called Ethereum 2.0, the entire release will be finished only at the end of 2022.
Polygon: Ethereum’s Internet of Blockchains 💻
Polygon is a framework that aims to solve the scaling issues on Ethereum like high gas fees, slow speeds, and security while providing fantastic interoperability with other blockchains like Polkadot, Cosmos, and Binance Smart Chain.
As a result of these unique features, Polygon’s native token MATIC has witnessed prodigious growth over 2021.
Since Polygon’s launch in May, the number of daily transactions on the network exceeded that on the Ethereum network on May 18th.
Transferring Assets from Ethereum to Polygon
Assuming you have an Ethereum based wallet like Metamask installed on your browser, transferring assets from Ethereum to Polygon is fairly easy using the Polygon Bridge.
Before doing so, I would advise looking at how to set up the Matic network on Metamask. The information can be found here.
Transactions on Polygon
The MATIC token is the utility token for all transactions on the Polygon network.
New users of the Polygon ecosystem may not have MATIC tokens available on their wallets. To address this, users can utilize faucets to obtain free MATIC tokens. These faucets allow users to redeem 0.0005 to 0.001 MATIC per redemption for a total of 3 redemptions in 24 hours.
Here are two of them:
Most transaction costs within the Polygon network cost fractions of a cent. Hence, each redemption from the respective faucets accounts for 50 to 100 transactions.
AAVE on Polygon 💰
It’s fantastic that one of the leading Defi lending protocols has launched on the Polygon network.
AAVE and Polygon have launched a joint campaign called #Defiforall. The goal of the campaign is to spread awareness that decentralized finance can be used by anyone regardless of their wealth or portfolio size.
Spearheading this campaign is Polygon’s $40 million liquidity program on AAVE. In short, the liquidity program rewards users for depositing and borrowing assets on the AAVE platform.
Liquidity Mining on AAVE
Let’s use the rates illustrated by the above screenshot taken on 15th June to compute rewards a prospective user can expect to receive.
Let’s say that a user called Sally wants to earn a passive income on $1000 worth of USD Coin (USDC). She deposits her USDC on AAVE to earn the deposit APY (1.66%).
In a year, Sally can expect to earn an interest of around $16 provided the interest rates remain constant.
However, as part of the rewards program, Sally additionally earns 2.23% on her investment in the form of MATIC tokens. Assuming the price of MATIC stays somewhat constant (around $1.5), she can expect to earn $22 in a year. That’s a 100% increase in the income earned!
Now, let us assume that Sally wants to borrow some crypto capital by collateralizing her deposits. AAVE allows users to borrow up to 80% of the total value locked (TVL) for the USD Coin (See image below). This means that Sally can borrow up to $800 worth of USD Coin for the $1000 worth of USD Coin deposited.
Let’s say she opts for a slightly conservative amount to borrow and ends up borrowing $500 or 50% TVL.
Now, Sally incurs an interest rate of 2.87% on the $500 she borrowed. This amounts to about $14 that she has to repay in interest in a year.
However, due to liquidity mining incentives, she earns rewards for borrowing assets. She earns 3.46% (around $17) in MATIC tokens for borrowing USDC.
Thus, the total money she makes on the entire exercise of borrowing + lending is:
$16 + $22 - $14 + $17 = $41This is the power of DeFi! By earning rewards, our user’s passive income has vastly increased.
Nonetheless, investors must be careful when using DeFi protocols as they do carry risks.
Don't Get Liquidated
You may have noticed the term liquidation threshold in the image above. This is the threshold ratio that users must maintain when borrowing assets against the collateral to avoid liquidation a.k.a. losing money.
For example, let us say that instead of USDC, Sally borrows WETH (wrapped Ethereum). Since WETH is a more volatile asset than USDC, a rise in its price may liquidate her position.
NOTE: Always be watchful of your health factor metric when borrowing assets.
In Sally’s case, she borrowed USDC against USDC. Both of them are relatively stable assets. Hence, her risk level is quite low.
Curve Finance on Polygon 💼
Curve Finance is a liquidity pool used to efficiently exchange Stablecoins. Much like decentralized exchanges like Uniswap, users can earn stake their tokens in a liquidity pool to earn rewards (interest).
This process of earning passive rewards on your staked crypto assets is called yield farming.
As you can see, the AAVE pool on Curve consists of three types of Stablecoins:
- DAI
- USDC
- USDT
NOTE: Users need to deposit only one type of Stablecoin to earn rewards on Curve Finance.
You might notice that like the AAVE platform, the AAVE pool on Curve has two rewards. The first is the base APY (3.98%) which is the normal interest rate. The other is the rewards earned from liquidity mining (21.51%).
NOTE: make sure that you “deposit and stake in gauge” to earn the liquidity mining rewards.
Providing Liquidity on Curve
Let us go back to our user, Sally. Currently, Sally has $500 worth USDC in her wallet that she borrowed from AAVE. She decides to put her borrowed money to work and deposits $250 USDC in the AAVE Curve Finance pool.
In a year, Sally will make 3.98% (~$10) and 21.51% (~$54) in MATIC tokens (assuming its price doesn't fluctuate) for a total of $64.
NOTE: Liquidity pools also carry risks with them. Be sure to understand the concept of impermanent loss before you invest.
Similar to the risks in the AAVE platform, providing liquidity for volatile assets such as Ethereum and Bitcoin on Curve can lead to greater impermanent loss than for Stablecoins like DAI, USDC, and USDT.
Sushiswap on Polygon 🍣
Sushiswap is a decentralized exchange that is an automated market maker built on top of the Ethereum blockchain. Users can not only trade their favorite tokens via Sushiswap but can also provide liquidity for pools used to trade these tokens and earn passive income.
Yield Farming on Sushiswap
Sushiswap has a large variety of yield farms to choose from to stake your tokens. However, as we have mentioned previously, yield farming on Stablecoin pools is the least risky.
Let’s head back to our DeFi investor Sally. She still has $250 worth of USDC left in her wallet to invest. From the image above, we can see that the USDC-DAI pool is offering a really lucrative yield of 96.81%.
NOTE: Unlike Curve Finance, users have to deposit both tokens to earn a yield on Sushiswap.
Hence, Sally decides to utilize the Sushiswap exchange to exchange half of her remaining USDC coins to DAI.
Now, Sally has enough DAI to provide liquidity on the USDC-DAI pool. She deposits equal parts of USDC and DAI to earn LP-tokens.
She now takes these LP-tokens and deposits them into the USDC-DAI yield farm pool.
Thus, now she can reap the rewards of the liquidity pool. Assuming that the rate of return (96.88%) remains constant, she is expected to earn around $242 in MATIC and SUSHI in a year.
Thus, by combining the total rewards earned from AAVE, Curve, and Sushi, Sally can make $347 on her initial $1000 investment in a year! 😯
I can guarantee (not really) that no bank in the world will provide competitive returns to DeFi.
Conclusion
So far, the DeFi ecosystem has been adopted largely by retail investors. Once institutions pour in, the ecosystem will witness exponential growth.
A growing number of believers have gone even further to say that DeFi can replace traditional financial institutions like banks. Ultimately, DeFi looks poised to have a bright future.
I hope you all enjoyed this tutorial on how to earn passive income on DeFi via Polygon. 😃
Until next time! ✋
