How Do DeFi Protocols Generate
Yield?
DeFi (Decentralized Finance) has opened the door to earning passive income from crypto assets. But how exactly does it work? Let's break down the yield mechanics the systems
that generate returns for users.
What Is "Yield" in DeFi?
In simple terms, yield is the income you earn on your crypto holdings. It can come in the form of more tokens, fees, or interest - similar to earning interest at a bank, but decentralized
and usually much higher.
How Do DeFi Protocols Create Yield?
Here are the main ways DeFi protocols generate returns:
1 Lending and Borrowing (Money Markets)
Platforms like Aave and Compound let users lend their crypto to others and earn interest.
Lenders deposit funds into a pool and receive interest from borrowers. Borrowers pay interest to access liquidity (usually by overcollateralizing with another token).
This interest is split between lenders and the protocol.
2 Liquidity Provision (DEXs like Uniswap)
When users provide liquidity to decentralized exchanges, they earn a share of trading fees.
You deposit a pair of tokens (e.g. ETH + USDC).
When others trade using your liquidity, you earn a % of the swap fees (usually 0.3%).
But beware of impermanent loss the value of your assets may change compared to holding them separately.
3 Staking
Some protocols revward you for staking (locking up) tokens, especially in proof-of-stake networks or governance tokens.
You lock tokens in a protocol.
You earn rewards (often paid in the same or another token).
This supports network security or protocol participation.
4. Protocol Incentives (Yield
Farming)
To attract users, DeFi platforms may reward liquidity providers and stakers with extra tokens- often their own native governance token.
These rewards boost returns in early phases.
A They often drop in value over time as hype fades.
5 Real Yield Some newer protocols share actual revenue (e.g., trading fees, loan interest) with users, instead of just giving out inflationary tokens. Thís is considered more sustainable.
