Crypto investors are utilizing DeFi lending protocols and products to “yield farm” and generate … [+]
DeFi “yield farming” is the latest meme exciting investors in the crypto universe. Yield farming is the act of leveraging DeFi protocols and products to generate high rates of return, in some cases reaching over 100% annualized yields when factoring in “cashback” bonuses and incentives.
As a refresher, Decentralized Finance (DeFi) is an ecosystem of decentralized applications enabling anyone with an internet connection to access a variety of financial products and services spanning crypto asset exchange, margin trading, financial derivatives, synthetic assets, algorithmic trading, and lending markets.
One of the first mainstream DeFi use cases is high-yield interest income in which users deposit their crypto to earn a high rate of return, often 100 times higher than the typical commercial bank savings account (i.e. 10% vs 0.1% APY). DeFi yield farming takes this basic concept and compounds returns by utilizing leverage to gain additional exposure to various crypto assets collateralized with USD-backed stablecoins.
For example, according to yesterday’s rates, a user who lent out 1,000 DAI (equivalent to $1,000), and took out a loan for $2,500 worth of the BAT crypto asset would have generated 77.48% APY in COMP rewards paid out daily, assuming a COMP token price of $360. This could all be done using InstaDapp’s maximize COMP mining feature. Users need to be mindful to maintain the appropriate collateralization ratio to prevent liquidation of their underlying 1,000 DAI position. Remarkably the COMP rewards exceed the cost to borrow BAT, making it profitable to borrow crypto.
A full tutorial is provided in the following video.
Multicoin Capital Principal Tony Sheng highlights some of these yield generating opportunities in the Twitter thread below.
Yield Farming Fuels Compound to Overtake MakerDAO
Overtaking MakerDAO last week, Compound is now the most popular DeFi lending protocol measured by total value locked, reaching over $550 million locked in the protocol. Compound was propelled by the launch of the protocol’s governance and rewards token, COMP. The COMP token was initially rewarded to liquidity providers and users on the Compound platform, and the token price quickly exploded from ~$16 to $360 in anticipation of its Coinbase listing on Monday June 22nd.
Compound’s current fully diluted market capitalization is $2.7 billion. However, some are voicing their concerns as the initial float, or circulating token supply available to market participants, is only about 25% of the total supply. Considering a large percentage of COMP tokens is hoarded by a few users and the top 10 addresses own 85% of the token supply, the actual float is considerably less allowing the token price to pump much more easily in the short term.
Each day, approximately 2,880 COMP tokens are distributed to users of the protocol. The distribution is allocated to each market (ETH, USDT, BAT, USDC, etc.) proportional to the interest being accrued in that market, with 50% of the distribution going to suppliers and 50% to borrowers. These “cashback” rewards to both lenders and borrowers combined with leverage is what is generating the outsized returns for investors.
High degrees of risk always accompany high rates of return. The nascent DeFi ecosystem is still finding its footing, and there will be multiple protocol exploits and blowups as the space matures, evident by the recent dForce and bZx exploits. Since DeFi protocols use automated smart contracts without intermediaries and crypto assets are bearer assets without the ability to roll back transactions, there is always the risk of a bug in the code or some other structural attack vector that hackers may exploit to steal user funds.
Ethereum Founder Vitalik Buterin voiced his concern over the inherent risks and the community’s overemphasis of high interest rate DeFi products.
Considering the average bank saving account interest rate is 0.1% and DeFi products can yield 100%+ annualized yields, are these products inherently 1,000 times riskier? Probably not, and thus savvy investors and traders are cashing in on these arbitrage opportunities. These rates will naturally decline over time as the space grows in size and volume and DeFi products become battle tested and hardened. Until then, DeFi yield farming will serve as a catalyst increasing user adoption and acclimating users to the notion of “unbanking” themselves.