DEFI FUNDAMENTALS

Understanding DeFi Yield Sources

Learn about the different ways DeFi protocols generate yield, from lending protocols to yield farming strategies. Discover how to identify real yield vs. inflationary incentives and understand the risks involved.

5 min read

Bill Evans

Introduction

What is Yield?

Yield in DeFi is the return you earn from putting your crypto assets to work in a protocol — this can include providing liquidity, lending, staking, or other strategies.

In all cases, you provide your capital to a protocol, and it generates yield for you.

What should not be considered Yield?

Things like pure capital gains (price increase of a token you hold) that's just profit, not yield. Also, one-time events like airdrops are usually not termed yield (they are windfalls). Generally, if your increase in value comes from external market pricing rather than a structured reward, it's not labeled yield. For example, if a token's price moons, that's a gain but not yield; however if that token regularly pays you a portion of fees, that portion is yield.

Inflationary (incentivized) Yield vs. Real Yield

Some protocols can simply increase the amount of tokens in circulation and distribute them to users. We consider this yield as inflationary (incentivized) yield.

In other cases, a decentralized exchange might distribute a portion of collected trading fees to those staking its governance token. We consider this yield as real yield.

What Are DeFi Yield Sources?

1. Lending Protocol Yield

One of the most straightforward ways to earn yield in DeFi is through lending protocols like Aave and Compound. Users deposit their assets (typically stablecoins or cryptocurrencies) and earn interest from borrowers who pay fees to access liquidity.

Yield source = fees paid by borrowers.

Example: Aave, Compound, Morpho generate yield to their depositors.

2. Revenue Sharing

A protocol like GMX or SushiSwap may pay x% of swap fees to providers of liquidity.

Yield source = fees paid by traders.

Example: GMX, SushiSwap, Uniswap, PancakeSwap, Trader Joe

3. Liquidity Mining

Imagine a foreign exchange office having only 1000 Turkish liras at an airport available for exchange. This is very low liquidity and can lead to customer dissatisfaction.

Same in crypto and DeFi. If some token has low liquidity, it can lead to high slippage. In order to increase the liquidity of a token, projects can provide incentives to other people to provide liquidity.

Liquidity Mining involves providing liquidity to pools. In return, projects reward liquidity providers with their tokens.

Yield source = incentives paid by protocols.

Example: Lido provided LDO tokens as rewards to those who provided liquidity to the stETH/other token pools.

4. Staking and Validator Rewards

Proof-of-Stake (PoS) networks like Ethereum reward users who stake their tokens to help secure the network. In case of Ethereum, part of this yield is inflationary (ETH issuance), but the rest is real yield (gas fees).

Yield source = transaction fees (part of the gas fees).

Example: Lido stETH token automatically rebalances and provides yield from ETH staking for its holders.

5. Real World Assets (RWA)

Some DeFi protocols are now bridging traditional finance with blockchain by offering exposure to real-world assets like Treasury bills, corporate bonds, and real estate. These RWAs generate real world yield that is then distributed to the DeFi users.

Yield source = real world yield generated by the RWAs.

Example: Ondo Finance

6. Delta-Neutral Strategies

In crypto derivative markets (e.g., perpetual futures), a funding rate is regularly paid between longs and shorts to keep prices aligned. If you take the short side on a perp when the funding rate is positive, you receive periodic payments from longs — effectively a yield on your position.

Traders can capture this by holding an equivalent long position in spot and a short in the perp ("cash-and-carry" or basis trade) to earn the funding as a market-neutral yield.

This funding rate yield comes from traders paying to maintain leveraged positions. It's a bit more complex and not a passive "set and forget" yield, but some protocols (e.g. Ethena) have automated on-chain strategies to capture funding rate yields for users.

Yield source = funding rate paid by traders.

Example: Ethena

7a. Risk Exchange (Backstop)

In some cases, protocols provide backstop to their users in case of a loss or liquidation. This protects the users from the risk of their position.

Yield source = premiums paid by traders/lenders.

Example: Liquity

7b. Risk Exchange (Options Premium)

Providing capital to sell options or insurance can generate yield in the form of premiums. For example, selling a put or call option means you earn the option premium upfront — a yield for taking on risk.

Yield source = premiums paid by traders.

Example: Opyn

7c. Risk Exchange (Insurance Premium)

DeFi insurance protocols (like Nexus Mutual) yield insurance premiums to coverage providers.

Yield source = premiums paid by insured users.

Example: Nexus Mutual

Other Types of Yield

There are other niche sources of yield. For example:

MEV rewards
Bribing rewards
...

Risks Involved

Most of the time, yield is not free. You are taking on risk by providing liquidity, staking, or other strategies.

For example, if you provide liquidity to a pool, you are exposed to impermanent loss. If you stake your tokens, you are exposed to protocol risk.