DeFi yield, explained: how to earn passive income on your crypto
DeFi yield is the return you earn for depositing crypto into on-chain protocols, generated through trading fees, lending interest, or token rewards.
Liquidity pools are the most common source: you deposit token pairs, traders use them, you collect a cut of every swap.
Not ready for DeFi? Centralized staking (like Kraken's) gets you yield without the smart contract risk.
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DeFi yield is the return you earn for depositing crypto into on-chain protocols, generated through trading fees, lending interest, or token rewards.
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Liquidity pools are the most common source: you deposit token pairs, traders use them, you collect a cut of every swap.
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Not ready for DeFi? Centralized staking (like Kraken's) gets you yield without the smart contract risk.
What is DeFi yield?
In traditional finance (or TradFi), idle money earns interest: you put it in a savings account, the bank lends it out, and you get a cut.
The same principles apply in decentralized finance (: the ecosystem of blockchain-based applications and protocols designed to mimic those of traditional finance, but without the intermediaries. Using smart contracts, these decentralized applications allow you to earn interest, rewards and fees (collectively, yield) on your crypto assets.
Put more simply: DeFi yield is the crypto you earn by putting your funds to work via on-chain protocols.
How does DeFi yield work?
DeFi yield works by rewarding users for providing a useful service to a blockchain network: this could be by lending funds, providing liquidity for trades, or staking to secure the network.
These rewards are generated in different ways, depending on the protocol: for instance, you may receive a share of trading fees, newly minted tokens, or interest from borrowers.
The “rewards rate” is typically represented as APY (or annual percentage yield). Unlike APR (which represents simple interest), the APY accounts for compounding over time.
Occasionally, you might see double-digit APYs, which seems like an almost unbelievable step-up from what your bank offers. Sometimes, it is — but other times, it’s a reflection of how risky the underlying assets are. More on that soon.
Liquidity pools: where most yield comes from
At its core, a liquidity pool is a smart contract that holds two tokens (e.g., WETH and USDC), whose price is set by an automated market maker (AMM) — a simple formula that takes into account the ratio of the tokens in the pool.
The majority of DeFi yields come from liquidity pools. That shouldn’t come as too much of a surprise, given that these are the engines that make decentralized trading possible.
A liquidity pool forgoes the need for an order book (as seen in traditional exchanges), with users instead trading directly with the contract.
Naturally, this means that there’s no centralized market maker. Instead, users are incentivized to become liquidity providers (LPs) by depositing an equal value of both tokens into the pool. In return, the protocol awards them LP tokens — a “digital receipt” representing their share of the pool. Every time a trade occurs, a small fee gets distributed to all LPs.
Impermanent loss explained
Impermanent loss refers to the difference in value between holding tokens in a liquidity pool versus simply holding them in your wallet. It occurs when the price of your deposited tokens changes relative to each other, causing the pool to rebalance your position in a way that leaves you worse off than if you'd done nothing.
Here’s why: when you provide assets to a liquidity pool, you don’t actually commit to holding a fixed amount of each asset, but rather a ratio of the two. As prices move, the pool rebalances automatically (and with it, your share).
It's called "impermanent" because it only crystallizes when you withdraw. If prices return to where they were at deposit time, the loss disappears. In practice, they rarely do — and once you withdraw, the loss is permanent. Trading fees earned from the pool can offset it, but during sharp price moves, they often don't.
That’s not to say LPing is a bad deal — it just requires some consideration.
Other ways to earn crypto yield
Liquidity provision is the main way to earn DeFi yield, but it’s far from the only one.
Lending protocols
Platforms such as Aave or Compound enable you to deposit tokens that other users borrow. When they do, they pay interest, which makes its way back to you. Rates tend to fluctuate with demand, which can increase or decrease the amount you receive.
Fazer staking
In Proof-of-Stake (PoS) networks, the blockchain is secured through financial incentives which require users to lock up their assets. Perhaps the best-known example of this is Ethereum, which rewards users for staking ETH.
Not ready for the full DeFi experience? Kraken offers staking directly on-platform — no wallet setup, no smart contract exposure, no gas fees. You can stake ETH, SOL and many assets in a few clicks and earn rewards without leaving the exchange. It's a lower-friction entry point if you want yield without the learning curve.
Yield aggregation
Yield aggregators like Yearn Finance automate the entire process. Users deposit their assets, and the protocol then shuffles these across various decentralized strategies to chase the best returns.
While this is a convenient approach, it does also add an extra layer of smart contract risk.
DeFi yield risks you should know
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Smart contract risk: Every DeFi protocol runs on code — with no humans to intervene if things go wrong. On numerous occasions, even high-profile dApps have been targeted and funds drained. While audits by reputable security organizations can help, they provide no guarantee that a protocol can't be exploited, either by malicious actors or catastrophic failures.
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Liquidation risk: When you borrow funds, you generally need to deposit collateral first. A sharp price decrease can trigger your liquidation (the automated closure of your position) meaning you lose your deposited assets.
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Stablecoin risk: Many DeFi yield strategies depend on stablecoins holding their peg to $1. If a stablecoin depegs (as happened with TerraUSD (UST) in 2022) the value of your position can collapse rapidly, regardless of the underlying protocol's security.
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Oracle risk: DeFi protocols rely on oracles to feed external data (like asset prices) to smart contracts. If an oracle delivers inaccurate or manipulated price data, it can trigger unfair liquidations, enable exploits, or cause protocols to misprice assets — putting your funds at risk.
Explore DeFi today
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These materials are for general information purposes only and are not investment advice or a recommendation or solicitation to buy, sell, stake or hold any cryptoasset or to engage in any specific trading strategy. Kraken does not and will not work to increase or decrease the price of any particular cryptoasset it makes available. Some crypto products and markets are regulated and others are unregulated; regardless, Kraken may or may not be required to be registered or otherwise authorized to provide specific products and services in each market, and you may not be protected by government compensation and/or regulatory protection schemes. The unpredictable nature of the cryptoasset markets can lead to loss of funds. Tax may be payable on any return and/or on any increase in the value of your cryptoassets and you should seek independent advice on your taxation position. Geographic restrictions may apply. See Legal Disclosures for each jurisdiction here.
Rewards are variable and not guaranteed; you can lose some or all of your assets. Interacting with on-chain smart contracts involves risks which are further detailed in the terms of service, including technological risk (bugs, exploits, and oracle/MEV/bridge failures), market risk (price volatility, de-pegs, and liquidation where relevant), and operational risk (irreversible transactions, gas fees, network congestion). Kraken does not control third-party protocols. Offered by Payward Wallet, LLC. Fees apply. Availability varies by jurisdiction.
Although the term "stablecoin" is commonly used, there is no guarantee that the asset will maintain a stable value in relation to the value of the reference asset when traded on secondary markets or that the reserve of assets, if there is one, will be adequate to satisfy all redemptions.