Part 3 of our series DeFi: the new financial frontier
In part 2 of our DeFi: the new financial frontier series we talk about how Blockchain technology is causing tectonics shifts in money systems with something called DeFi. As bank interest rates tank to record lows, company dividends take a hit and inflation climbs (see our inflation post here), financial freedom seekers and FIRE investors are falling on hard times. If financial freedom starts with saving more of your income, but your savings are going backwards, how do you get ahead? In this post, we talk about new opportunities to invest in DeFi crypto.
Lending with Decentralised Finance
We’ve already mentioned in our DeFI series that using Blockchain, anyone can lend their own money directly into DeFi crypto lending protocols and earn far better interest rates than the bank. This can all be done basically with a little bit of set up leg work and a few clicks of your mouse button. If you missed that post its important background for this one – you can find it here.
In this post, we’ll run through an example of how to make better than bank or term deposit interest on your fiat currecny, with DeFi.
We’re going to use a combination of the following resources so if you haven’t set these up yet that is a good place to start:
- An account somewhere you can buy Stablecoins and some Ethereum token – like a crypto exchange. We’ll use Binance.
- A web wallet to transfer your coins between the exchange and the lending protocol. We’ll use a browser extension wallet called Metamask but another is MyEthWallet. Actually there are tonnes of different wallets you can use – if you want to find the safest kind use a Hardware Wallet.
- A lending protocol. We’ll use Aave but others are Maker and Compound. You don’t need an account with them to lend money into their liquidity pool.
What interest rates can you get with DeFi?
The thing to know about DeFi crypto is interest rates fluctuate with market supply and demand. Shock horror I know. A world where banks don’t control interest rates, actual lending markets do!
We start on a DeFi crypto borrowing and lending platform called Aave. This example runs through a web based step by step, but there are a bunch of mobile based apps (wallets) that you can use pretty seamlessly to access an entire ecosystem of DeFi lending products. Its a whole new world of banking out there peeps! Here is a great resource if you want to earn interest on your crypto on the go with a list of the best mobile crypto wallets.
If you open Aave and click ‘deposit’ at the top of the screen you can find the lending and borrowing rates for different DeFi Stablecoins. If you’re not sure what Stablecoins are or how they are different to other crypto coins, take a look at part 1 of our DeFi series.
Now, not all of these are Stablecoins so the ones you are looking for are in red.
I currently have some Tether (USDT) which is a Stablecoin I bought with my Fiat money. It’s sitting in my Binance wallet. I’ve decided to lend that USDT on the Aave platform. Today’s interest rate is 5.22%. If you don’t own coins already, your first step will be to buy some on Binance and once you do it will appear in your Binance wallet.
The next step is to transfer the USDT from my Binance wallet to my MetaMask web wallet. Think of this step like taking fiat currency out of your bank account and putting it in your physical wallet so you can use that money.
If you’re using MetaMask for the first time, here’s a great article with some basic set up instructions for MetaMask wallet.
This is as easy as going into your Binance wallet, selecting the coin, then clicking transfer and entering in the amount you wish to transfer.
You then need to go into your web wallet and click and copy your MetaMask web wallet address for the Ethereum network. Once you have the address copied to clipboard, go back into the Binance transfer page and follow the prompts to paste in that address into the transfer screen. You then click transfer. Some verifications will happen and this all takes a few minutes.
I also need to transfer some Ethereum into my web wallet to pay the gas fees for using the Ethereum Blockchain. I use the same process to do this on Binance with same web wallet address from MetaMask but by selecting ETH instead of USDT as the coin I want to transfer.
Once you’ve completed the transfer you should see the coins in your Metamask wallet, but you may need to add the coin types to your MetaMask wallet first before they appear.
A word on ETH gas fees
As AAVE is built on the Ethereum blockchain, you need to use the Ethereum network and its token (ETH) to interact with AAVE. The ETH token acts as your ‘gas’ to use the Ethereum network. You’ll often see this referred to as ‘gas fees’.
One caveat in using DeFi crypto is that gas fees on the Ethereum network can be very, very high. The fees change with supply and demand and with transaction complexity. The fees work out to be exorbitant on small transactions, so economies of scale matter when you are moving Stablecoins around in order to lend them out or use them as collateral to borrow. If the gas fee is $225 (which it was when I went to use the Ethereum network this morning), then you need to move at least $7000 USD worth of USDT in order to recover the gas fees in your interest (transaction in and out of Aave) and stay ahead based on the lending rate for USDT in this example.
One way to get around the high Ethereum gas fees is to transact through the Matic network. This requires a slightly more advanced tech level. Matic acts as a sidechain to the Ethereum Bockchain. You will need to add the Matic network to your web wallet add funds to the Matic Layer 2 protocol to do this. Once you have the Matic sidechain set up and funded in your MetaMask web wallet, you then open the Matic Mainnet in your web wallet and connect your web wallet to Aave. The Aave integration should show that you’re in the Matic/Polygon sidechain.
There are a bunch of other ways and DeFi crypto products that help you to avoid ETH gas fees and we’ll go over these in other posts.
If you take a look on Aave using the Matic network you don’t have the same range of Stablecoins open for deposit or the same interest rates as you do using the Ethereum network. Fees are lower using Matic, but so are interest rates. So Matic is better if you’re lending smaller amounts but Ethereum pays off if your lending larger amounts.
DeFi crypto is still early days
Here we come across the catch with DeFi. Its nascent, so the actual use of the DeFi system isn’t quite living up the decentralised finance ethos because of the fees involved sometimes on the Ethereum network. Developers are working on computational ways of reducing fees and only once this happens will DeFi become practical for many smaller users. It can also be tricky to navigate at first and integrations between exchanges, wallets and protocols can be a bit buggy. The risks are also wildly larger than operating in the fiat money system. Be warned that this is speculative investment.
Depositing into Aave Liquidity Pool
After moving the USDT and ETH to my web wallet, I have to connect my web wallet to the Aave protocol. This is a simple click at the top right corner and a process of following their prompts.
Once connected I can transfer the USDT in my web wallet to the Aave lending pool by hitting ‘deposit’ at the top of the screen. This will take you to your web wallet interface so you can select the coin and transfer amount. Before I confirm the transaction, Aave shows me the gas fees involved.
The final word – higher interest is just a few clicks away
So now, my savings have gone from fiat, to USDT and have been deposited into the Aave lending pool. I’m now earning the market rate, which today you can see is 5.22%, but tomorrow could be different. You can still make money in your sleep if you’re prepared to risk more and lend larger amounts into these DeFi liquidity pools. Be sure to manage your risks as we mention here. Also, test the tech first with small amounts. Aave is a well known platform with over $18B USD equivalent in its Liquidity Protocol and the likes of Mark Cuban lending through it. But don’t put all your eggs in one basket because true to the Blockchain ethos, it’s a non-custodial protocol and that means if things go to custard, there is no protection for you.