Author：LD Capital Research
Edit: Noise z
DeFi has been all the rage since last summer in 2020. It saw the exponential growth in the volume and number of users, also acted as a prelude to the bull market. Last DeFi summer popularized the concept of liquidity mining, thus redefining crypto mining — mining rigs are no longer necessary for miners. It’s interesting to mention, that the work scope of mining has undergone a radical change from the traditional industry to the crypto market.
In 2021 there is now a surge of yield farming that offer a multitude of use cases such as liquidity mining, synthetic assets, fixed-rate products, staking etc. Crypto users flock to DeFi yet how it works has been somewhat confusing to those in the space.
There’s a famous line -
“Listen, here’s the thing. If you can’t spot the sucker in the first half hour at the table, then you ARE the sucker.” (Rounders)
A general rule of thumb — yield farmers need to make sure where do their yield come from, or else they lose money to others’ APY. It’s necessary to learn the APY structure of each yield farming protocols and to maximize the yield. Don’t be the sucker.
DeFi apps normally feature high APY rates.
Let’s get into the jargon of DeFi — APR and APY. APR stands for Annual Percentage Rate, which is the percentage of interest an investor or depositor will earn over a year. APY stands for Annual Parentage Yield. It is similar to APR, except that it includes the compounding of interest. With the same annual rate of return, the actual daily return of APY is lower than that of APR. The APY return would be even higher with compounding.
Of course, there could be misleading situation — some DeFi protocols confused APY and APR, it’s suggested that farmers calculate APYs on their own.
To understand how this works, let’s look at the 4 ways to farming:
1. Deposit collateral and receive interest
2. Deposit collateral and earn pool tokens
3. Stake LP tokens and earn interest and fees in liquidity pool
4. Earn yield by depositing tokens into a DeFi Vault
Well-designed DeFi apps work the magic between above strategies and offer sustainable revenue.
What’s the magic of leading DeFi protocols?
Let’s jump into various yield farming opportunities and their farming strategies.
AAVE—Lending and Farming Protocol
AAVE is an Ethereum-based protocol that allow users to lend and borrow crypto. Lenders earn interests by providing liquidity — APYs vary with token.
Interest paid by the borrowers — higher the utilization rate comes the higher the APY.
The current stablecoin APY is 2–3%. At present, most lending platforms share the same mechanism. They earn difference between the deposit- and loan APY, and charge the settlement fee.
AAVE was built at the early stage of DeFi and has successfully come back from hacks. It has relatively less risk and less earning.
Alpaca—Leveraged Yield Farming Protocol
Alpaca lenders deposit his token into lending vault and receives interest earning and ibToken — an interest-bearing asset. Staking ibToken also receives Alpaca the pool token. The current Alpaca stablecoin APY is around ~10%.
Alpaca increases the APY through the internal circulation of its platform (borrower and depositor of leveraged farming) and the price of pool token.
1. the APY deposit could be too high for customers to withdraw their principales (the capital utilization rate will be high simultaneously).
2. If an Alpaca user is forced liqudation, the platform needs to pay out compensation.
It could lose your money if the team’s reserves are insufficient.
Goose Finance—A Fork of PancakeSwap
Goose Finance Swap, a farming protocol with its pool token EGG, has an early-stage strategy — to increase TVL with high stablecoin- and LP mining APR. At that time, the project team innovatively adopted the deposit fee. Except for EGG and EGG LP mining, you will need to pay 4% of the deposit token to start the farming (fee used for EGG rebuy and burning, etc.), thus you need to first lose some money to fuel the pool token. As a result, the EGG price stays at a high level at the early stages of the project.
Rugpulls’ pool token, A token for short. Rugpulls share the same farming mechanism with Goose Finance but without the 4% deposit fee. Deposit stablecoin or provide token LP to farm A token with a relatively high APY. For example, with stablecoin APY 30%, A token can reach an APY of 1,000% or 10,000% but without any interest earning.
The allure of the rugpull and Goose Finance is the high APY payoff. The risks are as follows:
1. Existed bugs in the project code or lack of timelock. The project team or hackers may steal everything.
2. Sell-off of pool token due to unlimited circulating supply. Once the market capacity fails to consume the supply, the token price will free fall, which will lead to a death spiral. (10,000% APY farming will generate 200% tokens within three days, which will cause deflation and sell-off).
Liquidity—Interest-free Borrowing with Stablecoin
Liquidity APY earned by stablecoin farming and platform dividend — stake ETH to lend LUSD stablecoin minted by the platform without any interest. LQTY (Liquidity pool token) is farmed by staking LUSD. Users receive the platform transaction fee dividend by staking LQTY. The earning of staking the two tokens up to 30% APY.
Product risk is whether LUSD price can achieve being fixed to USD when a black swan event happens in the market. Also, if the price of ETH fell sharply, and users failed to refill their deposit, they will be forced liquidation.
Yearn Finance—Vaults like BUNNY and AUTO
After depositing token, the vault will automatically run with preset investment strategy, such as yield farming, LP farming and the vault will automatically reinvest the farming yield to maximize the earning. The vault will charge 0.5% of the principal and a small part of the investment earning as the cost of the platform to execute the strategy — the vault serves like a fund on the blockchain.
Potential risk: if existed loopholes in the DeFi projects or the vault, money may be lost.
How to Get Yield Now
On May 19, 2021, the price of XVS, the pool token of the leading lending protocol on BSC, was maliciously raised in the early morning — the bad actors then acquired a large number of BTC and ETH store in the VENUS pool by depositing XVS with the highest borrow rate. The price of XVS collapsed subsequently and caused automatic liquidation. However due to the crash of XVS, the settlement is failed and led to over 100 million USD bad debt — the users who deposited ETH or BTC on VENUS could lose their assets. This was one of the reasons that caused May 19th mayhem.
After the market crash on May 19th, Goose Finance alike rugpulls vanished while platforms such as Liquidity, AAVE, Alpaca survived the chaos — the reasons are that they operate with low borrow rates and only accept loans of highly liquid assets, which gained them stable users. Therefore, depositors with LP mining earn stable APY.
To participate in DeFi sector, you need to understand the basic logic of APY. You need to know where and who generate earning for you. Platforms like Liquidity, Aave, and Alpaca have users all the time because they have a stable business. In contrast, your APY is based on a security audit firm underwriting the security of the project itself and is generated from the platform profits and project value. If the price and circulation of the pool token run at an average level, your dividends (usually in the form of pool tokens) will thus at a reasonable price level.
However, the earning logic of Goosse Finance and other rugpulls is different. The pool token soared due to the low initial circulating supply and the high APY. The yield was only the pool token, and the APY was attached to the pool token price. Even projects like Goose charges deposit fees — to buy back and burn token in the purpose of stabilizing/boosting the price.
Once there are no newcomers and the market cannot consume the daily output of the pool token, the price of the pool token will collapse, followed by the APY slump. At the same time, the number of famers will decrease and sell-off the pool token, and TVL will also collapse, finally face the project’s failure.
After the crash, the number of high APY projects decreased significantly, and down with the number of new users and user activity. Billions reported loss from hack, which also urged users to transfer their assets to exchanges/wallets or prominence DeFi projects.
Fixed rate products are then launched by companies like Coinbase, Compound — with 4% APY. Better products are expected in the future, while funds seeking for a safe and high-yield place.
Fixed rate products are a low-risk and low-income option, while yield farming is a return accompanied by risk.
Fixed income and yield farming are like a fork in the intersection of DeFi, with rugged roads leading to a paradise on one side and flat roads leading to ordinary cities on the other.
When facing a downturn in the market, fixed income will be the safe choice for most people, while risk seeking players still into yield farming.
With the emerging of the industry, diverse products launched to suit the appetite of various people — it is suggested to select the farming platform based on the actual risk preference, capital volume, economic cycle, etc.
In our next post, we will review on fixed rate products. Stay tuned.
LD Capital is a leading crypto fund in investment and trading in primary and secondary markets, whose sub-funds include dedicated eco fund, FoF and hedge fund.
Owing to industrial resources and professional investment and research team, LD Capital has successively discovered and invested more than 300 companies in DeFi/infra/protocol/NFT/Dapp/Metaverse/DAO/Layer2/GameFi fields since 2016.
We have 30+ industrial experts around the world based in China, Singapore, Australia, EU and US, who worked for financial and high-tech companies like Visa, Cisco and now actively invest in blockchain companies.