Investors of all stripes have flocked to decentralized finance since it took the crypto industry by storm earlier in the decade, embracing its potential as a powerful alternative to traditional financial investments such as stocks, shares and real estate.
DeFi is built on the blockchain, giving investors the chance to engage in peer-to-peer transactions, cutting out the middleman and increasing transparency. Within this growing industry, there are hundreds of hugely tempting opportunities for investors willing to take a risk for the prospect of high returns. It’s also more accessible, with its decentralized nature opening the door to an entire class of retail investors excluded by traditional finance.
The beauty of DeFi is the way it’s automated with smart contracts, allowing anyone to engage in activities such as lending, borrowing, trading and “staking” at lower costs. Smart contracts are automated transaction agreements that execute when specified conditions are met, eliminating the need for a centralized authority.
With DeFi, some investors have made tons of money – that is not in doubt. But the world of crypto remains freight with risk, and many investors have been wiped out as a result of the volatility and speculative nature of crypto assets.
But with the rise of so-called “real world assets”, DeFi investors now have the opportunity to seek the best of both worlds. RWAs are tokenized versions of physical assets that live on blockchains, marrying the benefits of decentralization to more stable and predictable investment yields.
Investing in DeFi
Investors have an almost unlimited array of DeFi protocols to choose from, but to keep things simple, there are four basic ways to invest. One of the most popular, but demanding options is to trade cryptocurrencies on decentralized exchange platforms such as Uniswap and Pancakeswap. These platforms enable peer-to-peer trading without middlemen and do not require users to give up custody of their funds, meaning traders benefit from lower fees and increased security.
Trading in DeFi can be profitable, but it’s not so different from buying and selling stocks and shares, and requires investors to time the market to perfection so they can buy low and sell high.
Not everyone is cut out for trading, which is why most DeFi investors prefer to seek their fortune by “yield farming”, which is a vehicle that’s exclusive to the world of digital assets. Yield farming involves lending funds to DEX platforms, which require the capital for their users to trade against. Users deposit equal amounts of two cryptocurrencies in a “liquidity pool”, and these funds are used to facilitate real-time trading on the platform. In return, depositors get to earn a proportional share of the trading fees applied to those transactions, which are paid out in crypto.
An alternative to this is DeFi lending on protocols such as Aave, where users can deposit tokens into a “lending pool” that provides the capital for others to borrow against. They then earn interest on those loans as they’re repaid.
DeFi also offers “staking” opportunities, which is where users can lock tokens in a smart contract to participate in verifying blockchain transactions. By supporting the network’s operations, users can earn a share of the fees applied or “mint” new tokens as a reward. Staking is limited to “Proof-of-Stake” blockchains such as Ethereum and Solana.
Is DeFi profitable?
DeFi trading, yield farming, lending and staking activities can offer some enticing rewards for investors, giving them a way to earn a passive income on what would otherwise be idle assets. These investments can sometimes be extremely profitable, but the actual returns in dollar terms will vary based on several factors, including the specific token or project and the prevailing market conditions.
One of the major downsides to DeFi investing is the volatility of crypto itself. When engaging in DeFi activities, the rewards are paid out in cryptocurrencies, which means the actual ROI can vary wildly depending on the underlying asset price. During bull market conditions, investors can generate substantial yields very quickly, but if the price of the underlying asset declines, there’s a significant risk that all of their profits – and even their initial investment – could be wiped out.
There are other risk factors pertaining to security, too. Smart contracts can be riddled with vulnerabilities that can be exploited by ingenious hackers, and recent history is littered with reports of DeFi protocols being completely drained of investor’s funds.
When it comes to yield farming and lending, the publicized yields can fluctuate considerably in a short space of time. For instance, it’s not uncommon for protocols to increase their advertised APY to attract more capital in order to balance their liquidity pools, only to reduce it once parity has been achieved. According to Benzinga, the majority of DeFi yield farms offer APYs of between 5% and 10%, but sometimes they can offer significantly higher returns than this, and triple-digit returns are not unheard of. However, these kinds of APYs tend to be associated with the most speculative and volatile crypto assets, and may carry a level of risk that’s intolerable for most investors.
There have even been reports of some DeFi protocols offering returns of up to 4,000% APY, but the rewards are not derived from actual revenue, but “token emissions” (essentially, the creation of new tokens), and would rapidly diminish once these funds have dried up.
RWAs: More Stability For DeFi Yields
The unpredictable nature of DeFi yields explains why there is growing interest in a new class of digital assets called RWAs. Often known as “tokenized assets”, RWAs are digital versions of the physical assets found in the traditional financial world, such as stocks and shares, fiat currencies, commodities like gold and silver, and even things like real estate, bottles of fine wine, luxury artworks and carbon emissions.
Thanks to advances in blockchain and increased regulation, it’s possible for almost any real-world asset to be tokenized so it can be traded on the blockchain. The process requires some kind of legal framework that formalizes the rights of token holders to a physical asset. The advantages of RWAs include more efficient transactions and lower costs, fractional ownership, greater accessibility and more liquidity in previously illiquid asset classes.
These are not the only advantages of RWAs, though. What sets them apart from traditional DeFi is that they generate rewards that are tied to physical, revenue-generating assets, meaning they’re much less speculative investments with more stable yields for investors.
A case in point is EcoYield Energy, an emerging protocol that tokenizes green energy projects so anyone can invest in them. It’s making a concerted effort to open up the clean energy industry to a new class of investors. Previously, renewable energy projects were always restricted to raising funds from private equity, banks and venture capitalists, but EcoYield gives them the option of tapping equity provided by retail investors.
The protocol showcases numerous clean energy projects, including wind farms and solar farms that promise to generate verifiable on-chain yields for investors. In return for providing the capital they need to build up their infrastructure, investors can earn a share of the revenue they generate from selling their electricity.
What makes EcoYield interesting is the level of transparency. Investors can verify every aspect of the project, including their long-term Power Purchase Agreements that serve as a guarantee of future revenue. And the returns are not to be sneered at – for instance, one of its very first projects, a solar energy farm in Hull in the U.K., is offering a tempting APY of 25% paid out in USDC stablecoins. Investors can also take on a little more risk and buy and “stake” the platform’s native EYE token to increase the APY they earn.
Predictable, Real-World Yields
While RWA projects are still a relatively new development in the DeFi industry, some of the earliest protocols look like very compelling investment opportunities, offering a degree of security and stability that’s unheard of for digital assets.
Because they’re backed by verifiable, physical assets in the real world, RWAs can demonstrate that they’re generating real yields that are far more predictable than classic DeFi protocols. What’s more, many of these projects pay out their yields in stablecoins, which don’t suffer the volatility associated with typical cryptocurrencies. That makes it far easier for investors to estimate their expected returns compared to wildly unpredictable yield farming, lending and staking activities.
All told, RWAs are an exciting development in the DeFi industry that will likely appeal to investors looking for more predictable and lower-risk opportunities for building wealth.
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