Confused about crypto? Here's where profits come from.

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Warren Buffett famously said - "If?you've been playing poker for half an hour and you still?don't know?who the patsy is,?you're?the patsy."

A close relative of this maxim was coined re: social media as - "If you're not paying to use the product, you're the product."

And applying this to cryptocurrency could be - "If you're earning yield, and you don't know where the yield comes from, you're the yield."

Here are three ways interest-bearing crypto works, and the risks involved with each:

1.) Centralized Exchanges (CEX)

Buy crypto, hold it on an exchange, and you effortlessly receive more of that token. Pretty great, right?

It's great until the CEX handling your money makes bad loans.

CEX make money by:

• Holding your crypto
• Paying you a yield
• Lending your crypto out to others
• Keeping the spread for their profit

The third bullet point has been especially problematic lately. Risk management policies, or lack thereof, resulted in many bad loans supporting leveraged positions.

Voyager, Celsius, BlockFi, Genesis and many other CEX platforms have recently failed from poor lending decisions, and their depositors have lost some, if not all, of their money.

Using a CEX for yield, as easy & appealing as the process may be, has proven to be extremely risky.

Where does the yield come from on a CEX? You putting your assets into the hands of risk managers.

If you hold your crypto on a CEX, and that CEX is lending out your assets, understand where the yield is coming from.

The next two interest-bearing strategies will cover Decentralized Finance (DeFi), and how the yields work.

2.) DeFi through token emissions

What does Decentralized Finance (DeFi) actually mean?

DeFi is a series of permissionless systems. Unlike other financial tools (banks, brokerages, credit cards, etc.) which require you to create an account, DeFi allows anyone with a digital wallet to interact with the platforms.

DeFi platforms, then, are in a race to gather as many users as possible. Think about startup companies that have grown to become huge such as Amazon, Facebook, and Uber.

They've all succeeded where their competition failed by acquiring more users/customers.

DeFi is closer to Uber than the other two examples. Uber (and their main competitor, Lyft) attracted customers by offering subsidized rides - new users got to both try the new "push a button, get a ride" technology while paying less than the cost of a cab.

With DeFi, platforms earmark tokens as a reward for those using the platform. This is a component of what's called "tokenomics." Tokenomics - a mash-up of the word 'token' and 'economics' is the strategy used by crypto platforms to determine value.

Much like stocks, where the market capitalization is the price of a stock multiplied by the outstanding number of shares, crypto follows a similar formula: price of the crypto multiplied by the outstanding number of coins.

DeFi platforms - as a component of their tokenomics strategy - will earmark a portion of their tokens for emissions, which creates inflation. As the outstanding number of coins grows, it creates downward price pressure on the token.

Users on a DeFi platform could benefit from these pre-arranged emissions by participating via staking (providing liquidity), contributing to the community, or simply conducting transactions such as buying & selling.

Where does the yield come from in this DeFi example? Tokenomics designed to reward users, giving them more of the tokens from the platform. Poor tokenomics design could put your crypto at risk, as runaway token inflation drives down the price.

3.) DeFi through 'real yield'

Unlike emission-based yield, some interest-bearing options come from fee generation...coined 'real yield.' Platforms make money by providing a service, and those holding that platform's tokens can benefit as user adoption grows and value transacted increases.

Some crypto platforms offer us the opportunity to conduct fundamental research, such as a discounted cash flow analysis.

Where does the yield come from in this DeFi example? A platform earning money through fee generation. The main risk? People stop using the platform, and the fee generation disappears.

Earning yield on your crypto investments has great appeal, especially if the alternative is zero interest. Understanding where yield comes from, however, is critical to confidently participating in these platforms.

If you found this content valuable, may I ask for your help?

1. Which Web3 topics (crypto, DeFi, blockchain, metaverse, NFTs) would you like me to cover here in more detail? Please leave your comments.
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Thanks for reading! - Spence - spencerXsmith.eth

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