Depositing some of your money into DeFi Pools, where they offer rewards, can be a massively beneficial process to grow your income, but there are some drawbacks. There are a few concerns to discuss, like low volume and the complete collapse of a particular coin, but how can we stabilize our return?
DeFi Basics
When you add funds into a Decentralized Finance Pool, you essentially join an "automated market maker" market, where people can swap their coins for other coins instead of relying on traditional spot trading. Many of these pools apply a fee to every transaction, and you can benefit from that fee. When you put your coins in this pool, you can also receive a "pool token," which represents your share, in a crypto token, of that pool. With that new token received, there is sometimes an option to deposit that new token into "Yield Farms." In Yield Farms, you can earn extra interest in the form of a specialized yield token offered by the service.
For example, on Ben Swap (a Smart Bitcoin Cash DeFi Service), you can put money in a BCH - EBEN pool and get paid in EBEN.
The interest you earn using these services can boost your original pool's interest rate, starting around 2-12% interest (depending on trade volume and liquidity) to well above 20%, sometimes even 80%+. I've seen some DeFi pools offer 300%+.
Defi Risk
Impermanent Loss
Yet, those returns come with a risk. You have to be wary of these concerns such as impermanent loss, the collapse of one or all of the tokens you've used, or your Yield Farm token losing its value. Impermanent loss is one of those concerns where you can gradually lose wealth in a fiat currency you rely on where one coin becomes more or less valuable than another, or commonly, when both tokens lose their value to, for example, the USD.
Collapse of Value
The collapse of a random coin project that you like is a huge drawback, they may offer higher interest rates but they may have more risk. Sometimes, if you're fishing for those Yield Farming tokens, those tokens can also suddenly drop in value. So the interest rate that says 80%, could really just be 5% or if the fall of the value is steep enough, the interest rate can be negligible, in fiat.
DeFi with Stablecoins
The way how I see how to stabilize these problems while lowering general risk is by relying on a DeFi Pool where you can use a stablecoin, or when both tokens are stablecoins.
Impermanent loss is dramatically minimized when using stable coins as one token in your DeFi Pool. When using both, the impermanent loss doesn't go away, but it is even more greatly minimized because stablecoins are meant to peg to whatever fiat currency they are (many are even stablecoins for other cryptocurrencies). Just like all cryptocurrencies, even stablecoins are not always stable, as the name suggests. There are numerous examples like USDT (Ethereum), flexUSD (SmartBCH), TerraClassicUSD(Terra), etc. where these coins lost their peg to the USD and have collapsed in value. Some of these coins, like USDT, have regained their peg. This collapse of value applies to all cryptocurrencies regardless if they are "stablecoins" or not.
With that being said, to minimize the risk of Impermanent Loss, while being aware that all cryptocurrencies, including stablecoins, cannot always retain their value, and understanding that every cryptocurrency has risk, using Stablecoins in DeFi should be a priority. Those who love extreme risk need not heed my warnings.
What is your strategy with DeFi pools? Do you also add Stablecoin liquidity?