Once upon a time, investing in decentralized finance was a fairly simple affair that anyone could get to grips with, once they’d mastered the basics of crypto itself, of course.
But DeFi is a fast-moving industry where innovation never stops, and it has given rise to a range of advanced investing strategies that go well beyond the original passive income-generating opportunities like providing liquidity to a DEX platform or staking tokens to secure the network.
Most DeFi users will be aware of more sophisticated concepts like yield farming, which involves using algorithms to spread your deposits across multiple liquidity pools and automatically adjust those deposits frequently to extract maximum value.
But liquidity is where the money really is in DeFi. If you want to get the most out of your investments, liquidity is your best friend, helping you spread your bets further and faster than ever before.
Staking on steroids
One of the favored tactics for DeFi investors these days is “liquid restaking”, which is a concept that helps to resolve the illiquidity of staking assets to secure blockchain networks.
Liquid staking protocols issue depositors with liquid staking tokens, or LSTs, that represent the tokens they have locked in a smart contract. It’s an innovative idea, as DeFi users can take the LSTs and deploy them in other DeFi protocols to earn extra yields, in addition to the rewards they obtain from their original staked crypto.
The basic idea is that investors can still access their funds when staked to secure a network like Ethereum, so they can effectively invest those assets twice and earn double the rewards. It’s the equivalent of having your cake and stuffing your face with it. Such a thing will never be possible in traditional finance. Imagine buying some stocks for a company like IBM, and then being issued “stock dollars” that represent the dollars you used to buy your shares. It’s an impossible dream made possible by DeFi.
Incredibly, DeFi takes this concept even further. Nowadays, DeFi users can restake their LSTs on liquid restaking protocols such as EigenLayer, where they’ll earn additional rewards in the shape of “points”. And they’ll also be issued liquid restaking tokens, or LRTs, which can once again be used elsewhere, such as on the Kelp DAO protocol.
Kelp DAO allows users to deposit LSTs and accumulate a third layer of rewards, all stemming from their original staked crypto. Moreover, when users lock their tokens in Kelp, they receive a fourth token called KEP, which is a tokenized version of the EigenLayer points received for restaking.
This is a novel concept that provides even more liquidity to DeFi investors, as EigenLayer has not yet issued a native token. Instead, its rewards are “points” that cannot be traded, though it promises that users will eventually be able to redeem them once its token goes live. KEP basically makes EigenLayer points liquid, so they can be used in other protocols to generate a fourth rewards stream.
Liquidity pools offer deep rewards
Another interesting concept for DeFi investors is Liquidity Pool tokens, which bring liquidity to those who interact with traditional liquidity pools.
Liquidity pools are used by DEXs to ensure they have the liquidity they need to facilitate user’s trades. Like with traditional staking, a crypto user can earn rewards for depositing their tokens into a liquidity pool, only the difference is that these incentives come from the transaction fees charged by the underlying platform, as opposed to newly minted tokens by the network.
Traditionally, depositing tokens into liquidity pools meant the investor was left empty-handed, but just as with staking, innovators have changed that dynamic. LP tokens act as a receipt for the liquidity provider, who can use them to claim their original stake and interest earned. These tokens represent the investor’s share of the fees earned by the liquidity pool.
Various protocols offer LP tokens. On Balancer, they’re known as Balancer Pool Tokens or BPT, while on SushiSwap, they’re called SushiSwap Liquidity Provider or SLP tokens. LP tokens received are in proportion to the amount of liquidity provided, so if a user provides 5% of the liquidity to the pool, they’ll be issued 5% of the LP native tokens in that pool. The tokens will be added to the wallet used for liquidity and can be withdrawn along with interest earned at any time.
Liquidity providers receive a share of the transaction-generated fees accumulated by a liquidity pool, but they can obtain additional income from other DeFi protocols by using their LP tokens.
For instance, most LP tokens can be used as a collateral deposit to obtain a loan for more crypto, which can then be staked and restaked or whatever else the user wants to do. Platforms such as Abracadabra.money currently support LP tokens as collateral for loans.
Another possibility is yield farming, where LP tokens can be deposited into a yield farm, compounder or crypto vault to earn more rewards. For instance, yield farming services like Yearn.Finance and Aave use automated algorithms to help investors earn compounded interest on their LP tokens by depositing them in a range of different protocols.
By using these services, investors can obtain discounts because the transaction fees are shared between multiple users. They can also partake in various compounding strategies. For instance, one strategy might be to lend cryptocurrency via a platform that pays interest, then reinvest that interest back into the original cryptocurrency to try and increase the overall returns. Another example is an algorithmic trading strategy that automates the buying and selling of digital assets to try and earn profits.
An ocean of wealth
These enhanced liquidity strategies underscore the exponential growth in innovation within the DeFi industry. For projects to stand out, it’s becoming clear that simple rewards are no longer enough. These days, smart investors want smart liquidity strategies that can enable them to double, triple and even quadruple their rewards.
The DeFi industry is becoming more sophisticated by the day and it can leave many new investors confused. But those who know how to exploit a DeFi world that’s flooded with liquidity can potentially take advantage of that to reap some incredible rewards.
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