Introduction: Put Your Crypto to Work

You own blue-chip crypto like Ethereum (ETH) or Wrapped Bitcoin (WBTC). It’s sitting in your wallet, waiting for its value to appreciate. But what if it could do more than just sit there? What if it could generate multiple streams of passive income at once?

Welcome to the “DeFi Wheel”. It’s a leveraged yield farming strategy that allows you to use your existing assets to generate yield on top of yield.

In this article, we’ll provide a high-level overview of how this strategy works, its enormous risks, and why it’s not for everyone.

What is the DeFi Wheel? A High-Level View

The DeFi Wheel is a three-step cycle that you can loop to maximize the return on a base asset:

1. LEND: You deposit a volatile asset you plan to hold long-term (like ETH) into a lending protocol (like Aave).
2. BORROW: You take out a loan in stablecoins (like USDC) against your deposit.
3. EARN: You use those stablecoins to earn yield, typically by providing liquidity on a decentralized exchange (DEX).

The goal is for the yield you earn in step 3 to be greater than the interest you pay on your loan in step 2, all while your original asset (ETH) remains deposited and potentially appreciating in value.

Diagram: The DeFi Wheel Flow

            ┌───────────────────────────┐
            │      YOUR INITIAL ETH/WBTC      │
            └───────────────┬───────────────┘
                            │ 1. LEND
                            ↓
┌───────────────────────────────────────────────────┐
│             LENDING PROTOCOL (AAVE)             │
│    (You earn a small % for lending your ETH)      │
└───────────────────────┬───────────────────────────┘
                        │ 2. BORROW
                        ↓ (You borrow USDC against your ETH)
┌───────────────────────────────────────────────────┐
│               YOUR STABLECOINS (USDC)             │
└───────────────────────┬───────────────────────────┘
                        │ 3. EARN
                        ↓ (You deposit USDC into a Liquidity Pool)
┌───────────────────────────────────────────────────┐
│             LIQUIDITY POOL (CURVE)              │
│   (You earn trading fees and/or rewards)          │
└───────────────────────────────────────────────────┘

Complexity: Why This Isn’t for Beginners

This strategy is considered advanced for several key reasons:

• Active Management: This is not “set and forget.” You must constantly monitor your collateral’s price and your “Health Factor” to avoid liquidation.
• Multiple Protocols: You are interacting with at least two different DeFi platforms (a lending market and a DEX), each with its own risks.
• Compounded Risks: A problem at any layer (a hack on the lending protocol, a market crash) affects your entire position.
• Gas Fees: Every step (lending, borrowing, providing liquidity) requires blockchain transactions, which cost gas fees.

A Step-by-Step Guide to Spinning the Wheel

Step 1: Choose Your “Blue-Chip” Collateral

Use an asset you believe in long-term, like ETH or WBTC. The reason is simple: if the market crashes and you get liquidated, you want to be sure the asset you lose is one you wanted to hold anyway.

Step 2: Lend on a Blue-Chip Protocol (e.g., Aave)

Deposit your ETH into a well-established and audited lending protocol like Aave. By doing this, your ETH starts earning a small interest rate. This is your first income stream.

Step 3: Borrow Stablecoins Conservatively

This is the most critical step for risk management.

• Loan-to-Value (LTV): This is the maximum percentage you can borrow against your collateral. If you deposit $1,000 of ETH with an 80% LTV, you can borrow up to $800 in stablecoins.
• Health Factor: This is a metric showing the safety of your loan. If it reaches 1, you get liquidated.

Recommendation: Borrow very conservatively. A Health Factor of 2.0 or higher is good practice. This often means borrowing only 25-40% of your collateral’s value.

Step 4: Provide Liquidity (LP) to Earn Fees

With the stablecoins you borrowed, you can now earn yield.

• Option A (Lower Risk): Deposit your stablecoins into a stablecoin-only pool (e.g., the 3pool on Curve, which contains USDC/USDT/DAI). This nearly eliminates the risk of Impermanent Loss and earns trading fees.
• Option B (Higher Risk): Use a pool with a volatile asset (e.g., ETH/USDC on Uniswap). This can earn higher fees but exposes you to the significant risk of Impermanent Loss.

For a first attempt, Option A is strongly recommended.

The Two Big Risks You MUST Understand

1. Liquidation Risk

This happens if the value of your collateral (ETH) drops too much. The protocol will automatically sell your ETH to pay back your stablecoin debt.

Diagram: The Path to Liquidation

VALUE OF YOUR ETH
  $2,000   │----------------───┐ ▲ Health Factor: 3.5 (Safe)
          │                   │
  $1,500   │───────────┐       │ ▲ Health Factor: 2.0 (Caution)
          │           │       │
  $1,100   │──────┐    │       │ ▼ Health Factor: 1.2 (DANGER!)
          │      │    │       │
  $1,000   │------┼----┼-------┘-- LIQUIDATION -- (You lose your ETH)
          └────────────────────────────────────────────────────────

How to manage it: Borrow less, monitor your Health Factor daily, and have funds ready to repay part of the loan if the market drops.

2. Impermanent Loss (IL)

This risk only applies if you choose Option B in Step 4. It’s the value loss you experience when providing liquidity to a two-asset pool compared to just having held those two assets in your wallet.

In short: If the price of one asset in the pair changes dramatically against the other, the pool rebalances your position, and you can end up with less value than you would have had if you did nothing.

Where Does the Profit Come From?

Your potential profit is the sum of the yields, minus the cost of the loan:

1. Lending APY: The interest you earn from depositing your ETH on Aave (usually low, ~0.5-2%).
2. LP Trading Fees: The fees you earn from providing liquidity (variable, ~1-5%).
3. (Optional) LP Rewards: Some pools give out additional tokens as rewards (highly variable).

Minus (-)

4. Borrow Interest: The interest you pay on the stablecoins you borrowed (usually ~2-4%).

Hypothetical Example: (2% from Aave) + (4% from LP) - (3% borrow interest) = 3% net gain, all while you maintain your exposure to ETH.

Conclusion: Is the DeFi Wheel for You?

The DeFi Wheel is not free money. It is a powerful tool for experienced DeFi investors who:

• Are long-term bullish on their collateral (ETH/WBTC).
• Understand and are comfortable managing liquidation risk.
• Are willing to actively monitor their positions.

If you are just starting, focus on understanding each component separately. Lend on Aave. Swap on Uniswap. Provide liquidity to a stablecoin pool with a small amount.

Promise: In upcoming articles, we will break down each step of the DeFi Wheel into detailed tutorials. Stay tuned!

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Related articles:

• What is DeFi? A Beginner’s Guide: Understand the basics before attempting this.
• Crypto Wallets 101: Security comes first.