In the recent months, you may have come across the terms “Yield Farming” or “Liquidity Mining”.
It’s all the rage in the crypto markets these days.
What is Yield farming?
For those who haven’t heard of this term, Yield Farming is a meme that represents cryptocurrency investors putting their capital on into different DeFi protocols, to earn returns.
Now, your next question might be…
What is “DeFi”?
Well, DeFi refers to “decentralised finance” where financial services use smart contracts to automate enforceable agreements. This system uses online blockchain technology to eliminate the need for intermediaries like a bank or lawyer.
We can go deeper down the rabbit hole, but let’s return to Yield Farming.
How it all started
This article details my experience, which started 2 months ago, in July 2020.
Since Q2 of 2020, I’ve been hearing a buzz in the crypto sphere, on how cryptocurrency can now be deposited and lent out via various different protocols.
This wasn’t extremely innovative, since Maker have allowed us to collateralize ETH to mint a stable coin known as “Dai”. Dai is essentially a cryptocurrency that is pegged 1 to 1 , against the US dollar.
For those wondering what “Maker” and “ETH” are, I’ve included their description here:
- Maker is a cryptocurrency and a governance token. Cryptocurrency Maker (MKR) is a digital token created on the Ethereum platform of the project Maker, the main purpose of which is to create a line of decentralized digital assets that would be tied to the value of real instruments such as currency, gold, etc.
- ETH is a another type of cryptocurrency. We use ETH to power the Ethereum blockchain. It is scarce digital money that you can use on the internet – similar to Bitcoin.
What was more interesting though, was that anyone who supplied/borrowed such assets on the platform, got to earn the protocol’s token.
In this case, I am referring to Compound (COMP).
The COMP tokens that were given out, was of so much value…that even borrowers earned more from borrowing vs the interest they had to pay when using Compound.
Although there are various security concerns, price fluctuations and liquidation risks that investors undertook, the returns were high enough to attract participants.
That kickstarted the entire concept of yield farming.
While I missed out on COMP, I was fortunate enough to have participated in YFI farming.
Discovering Yearn.finance (YFI)
YFI is the token for Yearn.finance. It is used to govern the decision of the Yearn.finance ecosystem.
I remember it was a Saturday morning when I first discovered YFI. Being plugged into many different networks, I read about a new protocol that launched 6 hours ago (3am while I was sleeping). It was called YFI or yearn.finance.
The lead developer decided he would create a token called $YFI, to pass control of the yearn.finance suite of tools to a community. For us to obtain $YFI, we would have to stake stable coins such as Tether (USDT) or USD Coin (USDC). After assessing the risks, I decided to participate and began depositing my USDT into the staking contracts.
Risks of Yield Farming
Do note that there are various risks associated with yield farming, these include:
- Smart contract risks
- If there is a code or bug, your funds could be stuck and lost forever.
- Token price plummeting
- The beauty of yield farming is, even if the mined token price collapses, your mined token only cost you opportunity costs.
- I had to shift my funds out from Celsius, which was earning me an excellent 8% interest per annum. Should YFI token plummet in price, I would have lost out of 1 week of interest plus any gas fee incurred.
- Impermanent losses
- Since some of the mining includes the use of liquidity pools, there is a risk of impermanent loss when contributing to the pools.
My Results
During the week, I recorded an Annual Percentage Yield (APY) of 800% on my capital. And during the mining period, YFI peaked at $2000 per token.
Now, after almost 2 months later, $YFI is trading at ~$20k (as of Sep 20).
This has significantly impacted my cryptocurrency portfolio, with an overall growth of more than 40%!
This is possibly one of the most profitable case study I’ve had in my investment journey. It has exceed my returns from the $Zil ICO. Previously wrote about my $900 investment into $Zil that multiplied into $31,000 upon listing.
How to calculate your Opportunity Cost
In the case of $YFI, since I used capital to mine, I didn’t had to invest anything into the coin itself. Essentially, I was only losing out on “opportunity cost”.
Centralised exchanges as well as lending platforms offer interest when you deposit some cryptocurrencies. Thus if I used my assets for “yield farming”, I will not be able to deposit and earn these interest – resulting in my “opportunity costs”.
I did my calculations using the centralised exchange interest rate and my opportunity cost turned out to be about $300 per week.
My returns were $32,000 when the mining period ended. Hence, it was a good yield.
The future of Yield Farming
In my opinion, “Yield farming” aka “Liquidity mining” is simply the latest form of Initial Coin Offerings (ICOs) or Initial Exchange Offerings (IEOs).
Instead of going through an centralised exchange which costs developers money to list and market-make, there are decentralised exchanges now. The developers simply have to incentivise liquidity and allow the market to pool their tokens while earning newly minted ones.
There is one main difference though.
Right now as I continue to mine these new coins, I also have the ability to add liquidity into the various pools and support its price stability. This will benefit me, especially if the coin aims to innovate and improve the cryptocurrency space eventually, because its price will appreciate in the process.
Be on the lookout for scams
Since July, many different “farms” have popped up. Some have been sustainable, others have not.
Various exit scams have also emerged, which is typical of any novel investment vehicle.
Since I am not a coder, I can only monitor the team chats, twitter and medium posts before entering into the staking process. I tend to lose out on some early rewards. On the flip side, it’s less risky for my capital this way.
The current state of Cryptocurrency
After the ICO season of 2017/2018, the markets realised how important it is to have liquidity.
This brought about the IEO season of 2019, where centralised exchanges like Binance worked with teams to list their tokens and provide trading liquidity. If you remember, this caused a huge boom in prices for Exchange tokens.
In 2020, this has evolved and coins now list on DEXes (Decentralised EXchanges) with liquidity provision coming from the “retail” investors themselves. It has also allowed a fairer (or should I say different) method of distribution to early investors/supporters.
Final thoughts – Yield Farming presents a rare market opportunity now
At the time of writing, most of the yield farms I’m in (eg. YFV, Sushi, Hakka) provide me an Annual Percentage Yield (APY) of ~400%. However, I do not think this current 3-digits yield is sustainable.
It will eventually go down, and the markets will determine what the future APY is.
How long will it last? My estimate is anywhere between 6 months to 2 years.
Currently, there is still an information gap on yield farming. Hence, there is limited participation. (Which generally means each participant gets a higher yield.)
However, as new entrants continue to support/grow the price of the mainstream cryptocurrencies (BTC/ETH), some of these funds will eventually move into smaller altcoins and the “yield-farming” ecosystems.
With growing participation, it is inevitable for yields to drop over time.
As for myself, I’d continue to farm and take profits while the sun shines.