How to Generate Passive Income on Algofi

Upgrade your Algofi game with our strategies for all DeFi skill levels!

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Welcome back to the club, gov! 

After releasing our Definitive Algofi Guide, we received requests to outline strategies to put to work on the protocol. Today, we hope to deliver on that.

In the following guide, we outline three strategies for DeFi beginners, enthusiasts, and pros. We’ll review how to leverage the many features of Algorand’s DeFi hub while considering the risks and rewards to each. Each strategy is meant to be a thought starter, so we encourage you to modify each strategy to your liking.

To make this guide easier to navigate, we’ve included a table of contents below:

• Understanding the Risks

• Strategy Guide Overview

• DeFi Beginner Strategy

• DeFi Enthusiast Strategy

• DeFi Pro Strategy

• How to Build a Stablecoin Safety Net

Let’s dive in, starting with the risks. 

Understanding the Risks

Once you’re able to master managing your risks, you can begin to master DeFi. While it’s never fun to talk about losing money, we must always consider the possibility we will. This will help you to assess your risk tolerance level, manage that risk, and come up with plans of action to avoid losing money in the event the market turns for the worst.

With that being said, let’s review the risks of using Algofi’s platform and its many features:

1. Smart contract failure: Despite undergoing a full audit and rigorous internal quality assurance, there is a chance of smart contract failure which can lead to hacks or other exploits that put your assets at risk

   1. This is a real inherent risk to DeFi in general and Algorand isn’t immune to it. In January 2022, Tinyman experienced smart contract exploits and hackers got away with $3MM+ in digital assets

2. Liquidation: Users who fail to maintain a borrow utilization below 100% must be liquidated. To avoid this, we’d recommend keeping your borrow utilization between 10% - 20% (or lower) to start. Always know your liquidation price, so you can set price alerts to warn you when ALGO dips close to that price. 

   1. You can learn more about Algofi’s liquidation methodology and how to calculate your liquidation price here.

3. Oracle Risk: There is the risk that the oracles used by the Algofi protocol provide incorrect or stale data.

4. Slippage: Slippage occurs when a swap settles for an average price that is different than what was initially requested, and it often happens when there's not enough liquidity to complete your order or the market is volatile. This leads to the final order price changing. 

5. Impermanent Loss: When you provide liquidity to a LP and the price of your deposited assets changes compared to when you deposited them, you can experience impermanent loss. The LP is programmed to maintain a constant value between two tokens, so arbitrage traders will use the pool to swap the two tokens until the necessary constant value is achieved. 

   1. This is an important concept to grasp, and we highly recommend you do a deep dive into impermanent loss before becoming a liquidity provider. We recommend this video and article from Binance Academy as a starting point.

Evaluate your risk tolerance and decide what works best for you. Don’t forget: just because you can do something it doesn’t mean you should do it – even if it’ll produce a higher reward. That higher reward is almost always offset with a higher risk.

TL;DR: Don’t get rekt, gov.

Strategy Guide Overview

In the following guide we will present strategies for three different DeFi skill levels: beginner, enthusiast, and pro. Each strategy will get a grade from us on both their passive and risk levels on a scale between 1 - 3 with 1 being the least risky or passive and 3 being the most. Then we’ll list the risks to each strategy for your reference.

We recommend choosing the skill level appropriate to you to start, and then progressing through our ‘Level Up’ tips (which make each strategy more risky) before graduating to the next skill set. 

Go slow and small at first if you need to, especially considering the market conditions these days.

Gov Tip: Each strategy takes into account the Aeneas Liquidity Program rewards that will be distributed across the platform for the next three months. This means features that don’t currently produce additional rewards (i.e. staking STBL) weren’t considered. You can learn more about the Aeneas Liquidity Program here.

Okay, let’s review the strategies!

DeFi Beginner Strategy

Passive Level: 3 (Most Passive)

Risk Level: 1 (Least Risky)

Risks: Smart contract hacks, oracle failures

We call this one the stablecoin haven. 

To execute this strategy, you’ll lend either USDC or STB to earn yield and rewards. By lending stablecoins to start, you can learn the mechanics of DeFi in a relatively safe way. You don’t need to worry about liquidation or impermanent loss, and you can still earn a higher APR than any bank is offering right now.

And it’s extremely passive too!

How to Execute the Strategy

1. Lend Collateral: Supply USDC (~12%) or STBL (~9.5%) through the ‘Lend’ feature

2. Continue to build your USDC or STBL position: You’re getting paid to save after all. While building your position, take the time to learn about DeFi and experiment with different features on Algofi using a small amount of money.

How to Manage Your Risk

1. Don’t lend or stake more than you can afford to lose

You can level up this strategy by lending USDC to the protocol, and then borrowing STBL to use for staking. Due to the relatively 1:1 relationship between these two assets, liquidation risks are lower. Start with a low borrow utilization (~10% - 20% or less) in order to assess your risk tolerance to borrowing money in this space.

If you’re ready to take on a bit more risk, check out the DeFi Enthusiast strategy below.

DeFi Enthusiast Strategy

Passive Level: 2 (Moderate)

Risk Level: 2 (Moderate)

Risks: Smart contract hacks, oracle failures, and impermanent loss

Executing a strategy like this will require you to take on more work and risk as you split your assets between lending and mining liquidity. To maximize rewards, you can lend USDC and mine liquidity in the ALGO-STBL LP.

This is a less risky strategy that provides stellar returns. If you have experience with DeFi, particularly impermanent loss, this could be a strategy you may want to research more.

How to Execute the Strategy

1. Split Collateral: First determine how much of your collateral you want to lend vs. use for liquidity mining. This will be based on your own risk tolerance and which asset you’re lending, so make sure you consider all risks & rewards.

2. Lend Collateral: You can lend either ALGO (~6% APR) or USDC (~12%) to maximize your returns here. As mentioned previously, USDC is the least risky and most rewarding option.

3. Zap into a Liquidity Pool: Use the other half of your collateral to zap into the ALGO-STBL (~20%) and then stake your LP tokens in the ‘Farm’ section

   1. If you used USDC, you will need to swap it for ALGO or STBL first

   2. ALGO-STBL is clearly the most rewarding, but if you don’t want to expose yourself to the risk of impermanent loss then you can stake in the STBL-USDC (~13%) pool instead

4. Build a USDC Position: Continue to build a USDC position through lending to be rewarded for saving. You can also choose to save this money in the STBL-USDC LP if you wish, but it won’t help you build up a collateral position that you can borrow against in the future

How to Manage Your Risk

1. Don’t lend more than you can afford to lose

2. Stake in the STBL-USDC Pool to avoid the risk of impermanent loss and lower the chances that your assets are in a pool targeted by hackers first

You can level up this strategy by lending your total USDC position and borrowing STBL against it instead of splitting your collateral at the start. Remember to keep your borrow utilization low to minimize your risk.

Speaking of risk – let’s review the pro strategy next.

DeFi Pro Strategy

Passive Level: 1 (Least)

Risk Level: 3 (Riskiest)

Risks: Liquidation, impermanent Loss, smart contract hacks, slippage, and oracle failures

To execute a strategy like this one you will run the full gamut of Algofi’s features to maximize rewards, but in turn you will take on significant risk. And when we say full gamut, we mean it. You will lend collateral, borrow against your position then lend it back to the protocol to double dip on rewards, and mine liquidity.

This is by far the riskiest strategy, but it is the most rewarding. If you don’t have much experience with DeFi we’d strongly recommend you shy away from a strategy like this in favor of learning more & practice first.

How to Execute the Strategy

1. Lend Collateral: Lend either ALGO (~6% APR) or USDC (~12%) to maximize your returns. 

2. Double-Dip on Rewards: Borrow USDC (~5%) and then lend it back (~12%) to the protocol to double dip on rewards.

   1. Don’t take on additional risk just to execute this strategy. For example: if you were going to borrow 10%, consider splitting that into 2 or more transactions to double dip.

3. Borrow STBL: After you finish layering your collateral & loans, borrow STBL (~6.5%) due to the lower interest rate. Remember to manage your borrow utilization appropriately.

4. Zap into a Liquidity Pool: Finally, use your borrowed STBL to zap into either the ALGO-STBL (~25%) or the STBL-USDC (~13%) liquidity pools. 

   1. ALGO-STBL is clearly the most rewarding, but remember you put yourself at risk of impermanent loss with this pool. 

Gov Tip: At the time of this writing, the USDC borrow utilization is quickly approaching its optimal utilization of 70%. Once this happens, the rates to borrow USDC will soar to encourage a return to a lower utilization level. If this happens, you would be better off borrowing STBL in Step 2. You can learn more about how interest rates are calculated on Algofi here.

How to Manage Your Risk

1. Keep borrow utilization between 10 - 20% (or less).

2. Calculate your liquidation price and set-up price notifications to alert you when ALGO is a 10 - 20% dip away from that price.

3. Build a stablecoin safety net that you can quickly use to decrease your borrow utilization (via lending more collateral or paying off loans).

   1. More on this below

4. Practice your plan to lower your borrow utilization quickly. Don’t let the first time you’re implementing your plan be when your money is on the line. 

You can level up this strategy by repeating step #2 a few times to increase your rewards, but remember that each time you do this you’ll be increasing your borrow utilization and in turn your risk of liquidation. Don’t overextend yourself, and remember to always know your liquidation price and have a plan in place to de-risk quickly.

In fact, let’s talk about a few plans you can have in place to protect yourself next.

How to Build a Stablecoin Safety Net

To further manage your risk, remember to build a stablecoin position you can use to lower your borrow utilization quickly. You can lower your borrow utilization by either adding more collateral or of course paying off your loans.

You have a few options to build up a stablecoin safety net on Algofi:

1. Lend USDC to continue to lower your borrow utilization and liquidation risk while earning rewards.

2. Pay down your loans starting with the USDC loan to lower your borrow utilization and liquidation price with the ultimate plan to be debt free.

   1. You will want to de-risk yourself from your USDC loan first to avoid potential soaring interest rates as discussed above.

3. Stake STBL (~8%) within the ‘Stake’ feature on Algofi to get paid to build up a STBL position you can leverage quickly to lower your borrow utilization.

   1. Reminder: staking STBL isn’t included in the Aeneas Rewards program, but it remains the safest option especially if you plan to borrow against your collateral.

4. Stake and farm the STBL-USDC LP to earn an additional 13% (& .25% of all trading fees) while building up a position you can access to pay off loans.

   1. This option is not as quick as the others on this list due to the additional steps you need to take to unstake and burn your LP tokens.

Gov Tip: Remember to practice your plan to lower your borrow utilization a few times when your money isn’t on the line. Even going through the steps mentally without executing it on Algofi directly will help you prepare for the worse case scenario. 

So, what strategy are you going to test? One of ours or have you created your own? Let us know in the comments below.

And if you want more information on how to use Algofi and how the mechanics work on the backend, we highly recommend their official guide. It’s a wealth of information even if it can be a bit dense at times. The video guides in particular are a great resource if you find yourself stuck! 

As always, thanks for stopping by the Club.

Until next time, gov!

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Disclaimer: This isn’t financial advice! The investment strategies provided below are opinions.  As we say in crypto, don’t trust – VERIFY! Do your own research and don’t ever invest more than you’re willing to lose. Like any DeFi project, Algofi comes with risks. The project can fail, smart contracts can be hacked, assets could be compromised, users can be liquidated, oracles may provide inaccurate information, etc. You can learn more about the risks associated with using Algofi here.

Be safe out there and make sure you do enough research before you decide if Algofi is right for you.