Defi: Making money on layers

Previously covered:

  • Decentralization is expensive. A universal P2P system cannot be as efficient as a centralized one. But there are a lot of opportunities on the market for different peer-to-peer systems with different superpowers.
  • Each decentralized P2P system on the blockchain can become an ecosystem with individual users, use cases and relationships between these use cases.
  • Each modern ecosystem has a similar structure: the account layer, the node and incentivization layer, the algorithm layer, and so on.

Development of crypto-ecosystems is effectively stimulated by the economic component at each stage, both in short and long term. Mining, staking, and arbitrage are all built-in incentivizing mechanisms of the system. They take care of the system’s foundation, while volatility, ability to invest and use financial and other services keeps the users coming in, keeping those miners and stakers busy and well-paid. In fact, every successful peer-to-peer project and any part of its ecosystem is a tool for redistributing profits in an open (and decentralized) community. Therefore, it can be said that almost any action on the blockchain is used for incentivization.

We must stress that this material can not be qualified as financial advice, but rather as an overview of existing technology.

Let’s divide the ways of profiting from the incentivization into three blocks.

  1. Running blockchain infrastructure.
  2. Being a part of a blockchain community.
  3. Making money in crypto as a developer

1.  Profits of running blockchain infrastructure

We’re starting out with a community of individuals willing to exchange.

Individuals in this community create accounts which they can use for all types of exchange: speculating, payments, collecting, buying gaming gold etc. 

Ability to exchange is provided by a protocol, say a classic blockchain. It usually has a few classes of digital assets that cannot be double spent, sent and spent without permission from the owner of these assets. In most modern cases, blockchains also implement smart-contracts on top of the basic assets. These smart-contracts operate with tokens – another form of an asset on a blockchain. Tokens are programmable money: for example, they can be programmed to pay royalty for the initial owner in every transaction, have certain geographical restrictions, have a condition-based distribution, can be minted, burned or have any other type of coded rules built into them.

Once we have this system set, we’re looking at the infrastructure that can run complex protocols. Hence, it needs a lot of computing power, meaning it is expensive. And the “expensive” part is what we’re going to look at in this entry. So, who gets all the money for it, and how?  

First of all, in a transparent system, the upkeepers of the ledger are taking on a heavy task of holding, registering and verifying every transaction in the system. And they have to be paid in order to be interested in doing this heavy task, fairly and responsibly. Depending on the Consensus mechanism of the blockchain, we can highlight two main “upkeeping” jobs up there: 

1.1 Mining

Mining is still a king. It is the process of adding new blocks to the blockchain that uses a Proof of Work (PoW) algorithm. i.e. in order for the system to function, someone must package new transactions into blocks and attach them to the blockchain. Participants of this process are called miners. Miners from all over the world use processors and video cards to perform complex mathematical calculations confirming transactions, writing blocks and receiving a reward in the form of cryptocurrencies. Mining is still one of the most popular ways to earn money in crypto-economies. 

Users spend their personal funds on offline resources (equipment, electricity bills etc) and then receive online resources in return for their investment. Ways of incentivizing the miners contain: 

  • Incentives from users: Senders generally include incentives (rewards) in the form of the cryptocurrency, in which the transaction takes place (a small percentage of the whole transaction).
  • Block Rewards: A Block Reward is basically a reward given to a Bitcoin Miner for every Block for which he has solved the complex mathematical algorithm, and thus, the transaction records are added to the Blockchain.
    You can read up more on incentivization for miners in this article.

1.2 Validation

Since more and more blockchain implement Proof-of-Stake (PoS) Consensus, “validator” is becoming a more and more relevant and profitable position in the blockchain-upkeeping job market. Validators or validator nodes create new blocks in the blockchain. But the way they do it is different to the energy-demanding mining model. Validators do not compete to finish the mathematical problem first. Instead, the role of a new block creator is randomly assigned between fitting nodes with a balance above a certain threshold. The minimum staking amounts differ depending on the coin in question, but this can vary massively. In some cases the bottom for becoming a validation is $300.000 plus in a certain coin. To become a validator node of a modern blockchain protocol, you would also obviously need to have expensive and very stable equipment and good connection. 

1.3 Staking. Helping out validators:

The more a validator stakes, the more he gets paid. So, if you have coins in your wallet, you can always provide them to the validator node and receive part of the benefits. This process is called staking. 

Let’s take a look at this process in detail:

Users freeze (stake) a certain amount of coins on a cryptocurrency wallet, which are used to ensure the network’s performance. While the coins are staked, they cannot be spent, but they earn interest. Thus, the user is rewarded for allowing their assets to be used to keep the network running.

Formally, staking is similar to a bank term deposit. The principle is the same: the client deposits money into the account and cannot use it until the deposit expires. At this time, the bank uses this money for its needs, and the client is paid interest.

2. Being a part of a blockchain community

Community has always been the foundation of all business models. And by being a heavily immersed user, an early adopter, or a meaningful contributor, you can feasibly have more stake in the network depending on how those actions are monetized.

2.1 Basic volatility.

This is arguably the best known “way of making profit” on blockchain. 

The market of digital currency is most often volatile and has limited liquidity. This maximizes the profile of uncertainty for the asset investors of blockchain. Maximization of uncertainty, on the other hand, increases the potential that is present in the reward.

The method behind exploiting volatility of cryptocurrencies is simple: buying a certain cryptocurrency and selling it once its market price rises.

2.2 Arbitrage: Illiquidity creates an opportunity for sophisticated traders to come up with a crypto arbitrage strategy that allows them to profit from asymmetric prices quoted by different exchanges at the same time for the same token. Most of the big exchanges use proprietary price discovery systems, creating an opportunity to profit from any small differences between exchanges for a given crypto pair.

Arbitrage plays an important role in equalizing the value of assets between exchanges. It can be carried out manually or automatically through programmatic trading.

2.3 Startup Investing.

This is a more sophisticated form of exploiting volatility of cryptocurrencies than the previous one. It includes picking and supporting projects in the crypto-community. This type of investment can bring a generous reward as it is a combination of staking, becoming early-adopter, trading and helping out the promising and demanded project to be put on the map. Investment in a crypto-startup is usually high-risk. 

Developers are also known for giving all types of “goodie-bags” in the form of airdrops, high-interest and etc to the active members of the community. 

Startup investing has gone through the evolution of its own, with the foregone “teenage era” strongly associated with the form of startup investment known as ICOs. These are still a thing but are generally considered to be a disbalanced, high risk and speculative method of crowd-funding/investment. There are no scam-filters, audits. All stages of project-development, marketing, maintaining and growth rely on the developing team, a project is expected to allocate the project on its own.  

The current market is dominated by two significantly more mature and safe mechanisms of startup investments: IEOs and IDOs.

The former, transcribed as Initial Exchange offering, is a form for coin-offering, conducted by means of a Centralized Exchange platform. The platform assumes the responsibility for allocating coins for sale with subsequent distribution among the exchange participants. This is a significant responsibility shift and thus, a highly scrutinized process for Centralized Exchange platforms (which they then replenish with commission fees). This obviously leads to a much safer environment for investors. Plus, placing on CEX comes with its built-in liquidity. Again, the platform does not guarantee any demand for new tokens, yet filters out a lot of scam projects and malicious actors.

An IDO, or Initial DEX Offering is a new crowdfunding technique that enables cryptocurrency projects to introduce their native token or coin through decentralized exchanges (DEXs). It’s a foolproof method for projects to bootstrap themselves or raise money for growth and development.

This means that project developers are no longer required to gather assets for pools; instead, the pool is formed on a DEX after the IDO is completed via its own or a third-party launchpad.  The IDO model has grown in popularity since crypto projects can raise money without using intermediaries, and investors may benefit from instant token trading, resulting in a win-win scenario for everyone.

This is also where PolkaPad comes into play. Our platform allows members of the community to participate in IDOs with hindsight of drawbacks of ICOs and IEOs. We will talk more extensively about Launchpads in our later installment. Here’s a link if you want to skip ahead.

3. Making money in crypto as a developer

There are a number of different ways to profit as a crypto startup, depending on the startup’s proposal to the community,  the form of investment attraction, etc. In general, crypto projects generate revenue by charging transaction fees for every time someone uses the product or service. 

But at the end of the day, the profit and value of a startup (and then a business) is derived from the value of the asset, which this company puts out to the market. And this value is derived directly from the scope of the community/user-base. The more people a company can engage in its operations in a prolonged set of time, the more valuable its asset is. Therefore accumulation of the user base will always remain a key objective for any startup out there. 

We will go over and take a look at a user-base accumulating cycle in our next installment, so stay tuned.


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