1/35
Where do "Yield Farming" yields come from and how should you evaluate them?
Where do "Yield Farming" yields come from and how should you evaluate them?
2/35
A "yield" is something produced or provided as an outcome. We often use it to refer to things such as the crops that a farm produces, the bounty of grapes a farmer managed to produce is their "yield"
A "yield" is something produced or provided as an outcome. We often use it to refer to things such as the crops that a farm produces, the bounty of grapes a farmer managed to produce is their "yield"
3/35
Unlike a traditional yield, we could probably refer to defi yields more as "behavioral mining" - the contract isn't naturally producing tokens for no reason but instead as a reward in exchange for the user taking a behavior that is beneficial to the platform.
Unlike a traditional yield, we could probably refer to defi yields more as "behavioral mining" - the contract isn't naturally producing tokens for no reason but instead as a reward in exchange for the user taking a behavior that is beneficial to the platform.
4/35
These behaviors can be things like:
-Pooling the liquidity a contract needs to provide markets
-Adding liquidity to be a larger market maker or get a discount
-Pooling votes
-Or locking up specific assets.
Either way, the goal is to provide incentive to take an action.
These behaviors can be things like:
-Pooling the liquidity a contract needs to provide markets
-Adding liquidity to be a larger market maker or get a discount
-Pooling votes
-Or locking up specific assets.
Either way, the goal is to provide incentive to take an action.
5/35
The yield we see is often displayed as an APY.
It's probably a poor measure of actual gain, as it is rare that any of these yields last that long, have the liquidity to cash out, or are paid out all at once.
The yield we see is often displayed as an APY.
It's probably a poor measure of actual gain, as it is rare that any of these yields last that long, have the liquidity to cash out, or are paid out all at once.
6/35
The actual value you get underlying comes from one of a few possible places:
1) A team incentivizing actions with their own token (in which case it is really future buyers and speculators providing the dollar value because they believe in the worth of that token)
The actual value you get underlying comes from one of a few possible places:
1) A team incentivizing actions with their own token (in which case it is really future buyers and speculators providing the dollar value because they believe in the worth of that token)
7/35
2) A protocol paying out fees it captures by providing a service (such as Sushiswap's xSushi, where it takes the trading fees and uses them to buy and distribute more Sushi)
2) A protocol paying out fees it captures by providing a service (such as Sushiswap's xSushi, where it takes the trading fees and uses them to buy and distribute more Sushi)
8/35
Or
3) A protocol awarding fees (either in their own tokens or others) captured from another protocol. Such as Convex earning fees form Curve that it distributes.
Or
3) A protocol awarding fees (either in their own tokens or others) captured from another protocol. Such as Convex earning fees form Curve that it distributes.
9/35
The goal of all these models is to incentivize user actions to bootstrap the ecosystem.
Models #2 and #3 likely have to over incentivize at first, but the hope is that their payouts can eventually be self sufficient from only the protocol fees in the future.
The goal of all these models is to incentivize user actions to bootstrap the ecosystem.
Models #2 and #3 likely have to over incentivize at first, but the hope is that their payouts can eventually be self sufficient from only the protocol fees in the future.
10/35
But, right now, those protocols are rare, most of the yields we see fall into category #1, where the "yield" comes from the protocols own token as they bootstrap the protocol.
But, right now, those protocols are rare, most of the yields we see fall into category #1, where the "yield" comes from the protocols own token as they bootstrap the protocol.
11/35
The problem with this is that when taking this incentive path you need to ensure that the net benefit each user provides long term to the protocol is worth more than the cost, so that when mercenary capital goes away you are still left with enough to sustain the system.
The problem with this is that when taking this incentive path you need to ensure that the net benefit each user provides long term to the protocol is worth more than the cost, so that when mercenary capital goes away you are still left with enough to sustain the system.
12/35
Obviously most teams don't do that, and its why many high risk, high yield, yield farms end up collapsing.
So how do we evaluate these opportunities?
Obviously most teams don't do that, and its why many high risk, high yield, yield farms end up collapsing.
So how do we evaluate these opportunities?
13/35
As I mentioned, most opportunities are displayed in an APY - but not a real APY. If you stuck your liquidity into a protocol for a year, you would either overshoot or undershoot that estimated return quite drastically.
As I mentioned, most opportunities are displayed in an APY - but not a real APY. If you stuck your liquidity into a protocol for a year, you would either overshoot or undershoot that estimated return quite drastically.
14/35
Instead, you can probably think of these APYs as a type of score.
The score is ultimately some sort of function of risk, potential, and information asymmetry.
Instead, you can probably think of these APYs as a type of score.
The score is ultimately some sort of function of risk, potential, and information asymmetry.
15/35
It's important to remember that there is more capital in the world than there is opportunity; and so over time, all opportunities trend towards the lowest possible payout needed to sustain the opportunity.
It's important to remember that there is more capital in the world than there is opportunity; and so over time, all opportunities trend towards the lowest possible payout needed to sustain the opportunity.
16/35
In other words, if something is infinitely safe, and has good upside, it will pay a rate close to 0%.
However, in crypto we have two things that benefit our yield rates:
A) Risk
B) Information Asymmetry
In other words, if something is infinitely safe, and has good upside, it will pay a rate close to 0%.
However, in crypto we have two things that benefit our yield rates:
A) Risk
B) Information Asymmetry
17/35
On the risk front, you have things like:
-How established is the protocol
-Is there a single admin key
-How long does the payout rate last at this level
-Is it paying out from real revenue or just its own token (which may collapse shortly)
-Is it audited
On the risk front, you have things like:
-How established is the protocol
-Is there a single admin key
-How long does the payout rate last at this level
-Is it paying out from real revenue or just its own token (which may collapse shortly)
-Is it audited
18/35
-Is there substantial liquidity (Can I actually sell my yield all at this price into another asset without slippage)
-Will the assets I stake have a high IL
-Do the assets I'm staking have their own risks?
-What is the risk of the L1 that this is running on?
-Is there substantial liquidity (Can I actually sell my yield all at this price into another asset without slippage)
-Will the assets I stake have a high IL
-Do the assets I'm staking have their own risks?
-What is the risk of the L1 that this is running on?
19/35
It's not about simply is the single DApp itself safe or not, but the collective risks of the stack, and the 'risk' of the opportunity not working out.
It's not about simply is the single DApp itself safe or not, but the collective risks of the stack, and the 'risk' of the opportunity not working out.
20/35
After all, if you earn $100k in an asset and it collapses to $10k, you haven't lost any principal, but your money would have been more efficient elsewhere.
After all, if you earn $100k in an asset and it collapses to $10k, you haven't lost any principal, but your money would have been more efficient elsewhere.
21/35
Information asymmetry on the other hand means information you know that others don't.
That information could be about a protocol, a specific assets, its risks or potentials, or even just the ability to use crypto.
Information asymmetry on the other hand means information you know that others don't.
That information could be about a protocol, a specific assets, its risks or potentials, or even just the ability to use crypto.
22/35
Because less of the world's capital understands defi or is defi compatible, then if there were two opportunities (one defi, and one tradfi) that had the exact same risk, the defi one would pay out at a higher rate.
Because less of the world's capital understands defi or is defi compatible, then if there were two opportunities (one defi, and one tradfi) that had the exact same risk, the defi one would pay out at a higher rate.
23/35
Right now, the long term average rate of a low risk opportunity on tradfi markets is probably somewhere between 3% - 7% where as in crypto the range is wider and in the 5% - 30% bracket.
Right now, the long term average rate of a low risk opportunity on tradfi markets is probably somewhere between 3% - 7% where as in crypto the range is wider and in the 5% - 30% bracket.
24/35
Opportunities that fall into these ranges are likely things that are safer, more vetted, and more popular.
It isn't to say they are without risk, just that their target audience considers their risk to be tolerable.
Opportunities that fall into these ranges are likely things that are safer, more vetted, and more popular.
It isn't to say they are without risk, just that their target audience considers their risk to be tolerable.
25/35
When looking at yield farms things in this range are more likely older protocols with actual revenue and you can expect these payouts to last. They may even be a more accurate indicator of the amount of earnings you'll have at the end of the year (excluding asset variance)
When looking at yield farms things in this range are more likely older protocols with actual revenue and you can expect these payouts to last. They may even be a more accurate indicator of the amount of earnings you'll have at the end of the year (excluding asset variance)
26/35
Right now, even those opportunities in the 5% - 30% range are likely compensating the actual revenue yields by adding in some newly minted tokens that benefit from speculation to drive the APY return
Right now, even those opportunities in the 5% - 30% range are likely compensating the actual revenue yields by adding in some newly minted tokens that benefit from speculation to drive the APY return
27/35
I think in terms of actual, real revenue distributed, that Sushiswap's xSushi is the only yield farm protocol that has only revenue yield distributed at scale, and that averages somewhere in the bracket of a 6% APY (excluding appreciation)
I think in terms of actual, real revenue distributed, that Sushiswap's xSushi is the only yield farm protocol that has only revenue yield distributed at scale, and that averages somewhere in the bracket of a 6% APY (excluding appreciation)
28/35
That doesn't mean that yield farms that are distributing their governance token without having revenue yet are bad, or that they aren't a great opportunity.
It just means we can't realistically expect those APYs are sustainable from long term value capture.
That doesn't mean that yield farms that are distributing their governance token without having revenue yet are bad, or that they aren't a great opportunity.
It just means we can't realistically expect those APYs are sustainable from long term value capture.
29/35
When evaluating a yield farm, you have to ask yourself not only about the risks but:
-Is there enough liquidity?
-How long will this opportunity last?
-Do I care about APY return or ownership % return?
-Would my money be more efficient elsewhere?
When evaluating a yield farm, you have to ask yourself not only about the risks but:
-Is there enough liquidity?
-How long will this opportunity last?
-Do I care about APY return or ownership % return?
-Would my money be more efficient elsewhere?
30/35
After that, flip it on its head, think about it not from an investor perspective but from a protocol perspective.
Ask yourself:
-What benefit does the protocol get out of my staking?
-How long does it last?
-Will they still have some benefit if they stop the reward?
After that, flip it on its head, think about it not from an investor perspective but from a protocol perspective.
Ask yourself:
-What benefit does the protocol get out of my staking?
-How long does it last?
-Will they still have some benefit if they stop the reward?
31/35
This can help you to identify good strong protocols that will last with real value. Far too many protocols will pay you for staking in their platform with their token, but that staking doesn't actually do anything.
Which means its set to crash.
This can help you to identify good strong protocols that will last with real value. Far too many protocols will pay you for staking in their platform with their token, but that staking doesn't actually do anything.
Which means its set to crash.
32/35
A 200% APY may indicate risk and may only last for a few hours if the pool dilutes.
A 20% APY may indicate a more robust opportunity and if that opportunity lasts for a few days rather than a few hours, you'll end up better off.
A 200% APY may indicate risk and may only last for a few hours if the pool dilutes.
A 20% APY may indicate a more robust opportunity and if that opportunity lasts for a few days rather than a few hours, you'll end up better off.
33/35
When you get to crazy high 10,000%+ APYs it's no longer rational risk calculations.
You are gambling in a speculative ponzi.
Which is fine as long as everyone knows they are gambling and understands the risks.
When you get to crazy high 10,000%+ APYs it's no longer rational risk calculations.
You are gambling in a speculative ponzi.
Which is fine as long as everyone knows they are gambling and understands the risks.
34/35
There are a lot of people out there chasing these insanely high APY farms when it wasn't worth the risk.
If you bought Ethereum last year and shoved it in a stable farm you are up over 10x from appreciation and 50%+ from yields + their appreciation.
There are a lot of people out there chasing these insanely high APY farms when it wasn't worth the risk.
If you bought Ethereum last year and shoved it in a stable farm you are up over 10x from appreciation and 50%+ from yields + their appreciation.
35/35
Obviously none of this is financial advice. What is right for you may not be right for others. But, understanding where yields come from, and why they are a benefit to the protocol and not just free money, may help equip you to better evaluate the best opportunity.
Obviously none of this is financial advice. What is right for you may not be right for others. But, understanding where yields come from, and why they are a benefit to the protocol and not just free money, may help equip you to better evaluate the best opportunity.
Loading suggestions...