Have you ever wondered how some crypto sites can offer ludicrous APRs? Here’s a short primer to dive in – and as this is a primer, some concepts/ background are edited for clarity.
Some of the most promising sites/ tech in DeCentralized Finance (DeFi) are DEXs. A DEX (decentralized exchange) facilitates trading round the clock, every day of the year, without requiring a username or password. You retain custody of your crypto on your own cold wallet hardware (say Ledger or Trezor). Once the transaction is recorded on the blockchain the ownership/ settling of the asset is done automatically – there is no T+2 settlement like in TradFI (Traditional Finance).
Let’s use GMX (on Arbitrum / Avalanche) as an example – if you want to swap say your ETH to USDC, you go to the Trade page and execute your trade just like you would on a centralized exchange:
Now, you may ask yourself – all these centralized exchanges (Coinbase, Binance, Nasdaq, NYSE, GS dark pools etc) – how do they make money? Well, they make their money on trading – pairing Bob who wants to buy ETH for $2000 from Alice, and charging a fee (price difference or transaction fee) for the service.
Imagine that all for example ETH owners, including Bob, could “Pool” their ETH (in a Liquidity Pool), allowing them to earn fees on ETH trades. Essentially the ETH is placed in a ‘vault’ or smart contract that pools your ETH with other DeFi users. Then you as a “Liquidity Provider / LP” earn a good chunk of the fee revenue that accrues to the pool – as a percentage of your ownership in the pool.
Throughout history a centralized/ third party has earned these fees. With DeFi you still custody the assets (you are the only one with the private keys). This is at the core of DeCentralized Finance – getting rid of the intermediaries, and allowing the actual owners of the assets to benefit.
So what kind of rates can earn in these pools? On GMX V2 pools today:
And we’ve heard Ethereum transactions are expensive right? GMX runs on Arbitrum – an ETH Layer 2, and transactions are normally 10c-20c… (and will get cheaper..).
Remember these are new technologies, where some sites/ users have been hacked, you take on smart contract risk, risk of owning the crypto asset etc, but it’s not ‘Fake SBF / Terra Luna’ yield, it is native yield based on fee generation. Always do your due diligence on the sites you use – personally I prefer the larger DeFi sites with a higher TVL (total value locked), higher revenues, clear open-source code on Github for all key functionalities etc…
Finally – this is NOT financial advice, be careful out there 🙂