What is Passive income
Passive income is income generated from investments where the investor does not have to actively work in order to make the investment grow. In the Crypto space there are a number of areas where passive income can be earned of which the most popular are currently Mining, Staking, Lending, Yield Farming and Liquidity Providing.
What is Mining
Mining cryptocurrency is the original form of earning passive income in the cryptocurrency space using the original consensus algorithm, Proof-of-Work. Miners will compete against each other to solve complex mathematical problems and verify transactions on the blockchain. The fastest miner to solve the puzzle will win the right to produce the next block on the blockchain and in turn be rewarded with crypto coins or tokens.
Bitcoin: The Early Days
In the early days of Bitcoin this was relatively easy and an everyday computer could be used. As the competition increased, miners were forced to use more energy and more power to retain the same success. Today cryptocurrency mining has become mainly a corporate business where there are large mining farms using hundreds of ASICS (Application-Specific Integrated Circuits) and large amounts of electricity.
What is Staking?
You can stake your crypto by transferring specific coins from a cryptocurrency wallet to a blockchain validator node in order for them to support the security and operations of a blockchain network. The reason your assets receive rewards whilst being staked is that the blockchain validator puts your assets to work using a proof of stake (PoS) model. This process is used to ensure that all transactions are verified and added to the blockchain.
The Pos Model
It is important to note that staking is only available with those cryptocurrencies that use the PoS model. PoS is a more energy efficient alternative to the proof of work model used by Bitcoin and Ethereum1.0 currently use.
There are cases where you have to add or delegate funds to a staking pool but on the whole exchanges will do this for you. Some examples of coins that can be staked are Polygon (MATIC), Terra (LUNA), Polkadot (DOT) and Binance (BNB)
What is Lending
Lending has become very popular way of earning passive income in the crypto industry as it returns a far higher interest rate than a bank would pay for a cash deposit. The basic values of lending crypto are the same as traditional cash loans in that you can lend your assets for a chance to earn interest and in the case of crypto you are lending your digital assets. There are four main ways to lend in the crypto arena which are as follows:
- Peer to Peer Lending (P2P) allows you to lock up your assets for a period of time in return for collecting interest payments at a later date. The system allows the users to set the terms on the amount they want to loan and whether the interest rate should be fixed or set by you based on the current market rate.
- Centralised Lending (CeFi) allows you to deposit your assets with a third party provider where the interests and lock up periods are fixed and in return the user earns interest (typically paid in the deposited assets). Popular CeFi lenders include BlockFi and Nexo.
- Decentralised Lending are autonomous lending protocols where there is no third party involved. It allows users to execute lending services directly on the blockchain via smart contracts-powered lending pools to earn interest. Popular Defi Lenders include Compound (COMP) and Aave (AAVE).
- Margin Lending is where the user can lend their crypto asset to traders to trade and get repaid the loans with interest.
Liquidity Provider & Yield Farming
What are Liquidity Pools
Another popular way to earn passive income in the Defi markets is by depositing your crypto assets into decentralised liquidity pools. Liquidity pools provide the liquidity required by decentralised exchanges that allow trading to take place. By doing this you become a “Liquidity Provider”. In return for providing liquidity to these trading pools, the user will be awarded both trading fees and LP tokens (Liquidity Provider tokens).
As a Liquidity provider (LP) you will hold LP tokens which gives the LP the option to stake their LP tokens in something known as a “yield farm” which will generate additional yields in the form of cryptocurrency. This essentially means that while your pooled assets are earning a share of all the trading fees your LP tokens are also earning rewards.
Popular Decentralised exchanges with liquidity pools include Uniswap (UNI) and Pancakeswap (CAKE)