Continuing from this article.
Here we will make an example study of $YEL token using their project tokenomics documentation and Graham’s P/E (simplified).
This is not financial advice.
Preliminary token selection
$YEL is a fairly new token released at the beginning of August 2021, it is not a meme coin with a dog name, it is not a copy of an existing project, it is not a gaming token, it is not fan token of any sort. Their purpose is to make something new in DeFi: an automated portfolio manager that resembles an ETF of farming pools across multiple chains: the premise is good.
The idea is that users will choose a risk level, deposit a dollar value — using the chain native token as medium to move this value — that will be invested in many farms following the chosen risk level; differentiating the investment, optimizing and re-balancing continuously. Users will see the dollar value of the investment fluctuate following the marked fluctuations, but slowly it will diverge positively (there will be more money than just holding the benchmark). How slowly depends on the risk level: on low risk slower than on high risk. When a user withdraws he will be given his equivalent dollar value using $YEL as moving medium.
So far so good: the protocol is innovative: this is new.
Let's see if it is sustainable: where are the money coming from?
First of all they have 400M tokens and they plan to let community vote to make this the fixed maximum number of token available. This is good because there will not be emission inflation.
They will take fees from the main "ETF" service (called Equilibrium) and from other side services, these fees will be used to buy $YEL on the market and then distributed to $YEL owners if they deposit their tokens on the staking pools.
This is good: the token will have dividends like a stock — meaning we can apply P/E. Still: so far so good.
No one can predict the token value, but we can make some reasonable assumption and from there do some math to see where it brings us.
Let's do it:
Redistribution pump explained
If you understand this concept you will know more than 80% of people in crypto space: an asset that gives a yield has a value that is proportional to that yield and inversely proportional to the risk of that asset.
How much would you pay for a house?
If you could rent that house, forever with no risks, for $10.000,00/year, the risk factor would be very low, and the yield would be constant.
Say you offer $20.000,00 for the house. If you mange to buy it you would have all your money back in two years just by renting: an APR of 50% on a safe investment. This good! So good that probably you would have another person competing with you to buy such a good investment. So they offers $30.000,00 because they agree to have all their money back in three years: 33% APR is still super good on a safe investment.
You don't want to lose this fight, you offer $40.000,00 because you can manage to go in par in four years! 25% APR still good.
This raise in price will continue until one of the parties think that the next raise would not be acceptable. In our example the final price could very well be $200,000.00 or more (APR 5% or less), because safe investments today are under 3% APY (just check US Treasury Bonds).
This is an example to show why the price of an asset will raise proportionally to the yield it generates: if for some reason you could rent that house for double the price, the total value of the house would be doubled.
Let's say a safe investor will pay maximum a price that is 20 times the rent: he at maximum want to get all his money back in 20 years. This is a benchmark of a safe investor.
Let's talk about risk now.
Say the same house is in an earthquake area: earthquake insurance costs $2,000,00/year. You still can rent the house for $10,000.00/year — but — a safe investor will use part of those money to pay for insurance: now he will have only $8,000.00 of usable yield.
To get all his money back in twenty year — our benchmark — a cautious investor now need to pay $160,000.00 maximum instead of the old $200,000.00 of a safe house.
But there is a big point here: there are investors that agrees to risk more.
One may agree to pay $165,000.00 a house that gives $10,000.00/Year, beating the safe investor on the price, then they may don't cover for the added earthquake risk and keep all the rent.
In that case they would get all their money back in 16.5 years: APR of 6.06% instead of the 5.00% on the safe investor.
There is more: now say that house is also inside a forest that have a big fire risk. The boring safe investor will pay $2,000.00 for the earthquake insurance and other $2,500.00 for the fire insurance, each year!
Now his revenues are only $5.500,00/year: to get all his money back in 20 years he will offer maximum $110.000,00 for that same house.
But again: an investor that want to risk more, or thinks for whatever reasons that there will be no earthquakes or fires, will get that house for as low as $115,000.00 (since the safe investor will not want to offer that much).
If our risky investor don't pay for insurances, he will have all his money back in 11.5 years (or he will lose the house in a fire, whichever comes first): 8.60% APR.
As you can see the higher the risk to lose the house someone is willing to have, the higher the APR they will receive on their investment: this is an example of how the APR of an investment grows with the risk; at the same time if you want to keep the risk stable (buying insurances in this example) you will have to lower the price.
This is true on every investment: APR is a measure of risk.
"Oh thanks -DvD-! But what do I do with all these information if I want to study a token?"
A governance token is no different from a house: you get dividends (rent) you pay a price to own it, and it has an intrinsic risk.
If we manage to figure out how many dividends it will generate and how much risky it will be — compared to market benchmark — we can have an idea of the market price at which people will most probably agree to buy and sell it.
Staking pools
In DeFi revenues of a project are usually given to investors using staking pools. They come in many forms and details, but the general principle is the same; since we are studying $YEL I will explain Yel.finance version here.
We will analyze later how and what will be the revenues of the protocol, now let's assume these revenues are already collected and ready to be distributed to investors in the form of $YEL tokens.
To be a Yel investor you have to buy $YEL tokens. If you just hold the tokens you will not be able to participate in the earning redistribution (dividends): you will need to stake your tokens in the staking pools.
Yel will take all the dividends it has collected in a period of time, let's say one week, and give them to all the people that have deposited their tokens inside the staking pool, proportionally to their share of the pool.
This means that if there are 1.000,00 $YEL tokens deposited in the staking pool, and you have 500,00 of them, you own 50% of the staking pool share.
You will receive 50% of all $YEL dropped in that pool.
If nobody exits or enters that pool you will receive 50% of the dropped revenues forever. This will not be the case because people will continuously enter and exit the staking pool.
Since the total number of existing $YEL token is fixed at 400M, at maximum all these 400M tokens will be deposited in the staking pools. For many reasons we cannot discuss here the actual number of token deposited in the staking pools will always be less than 400M. But for our example we can assume that someone owning 1M $YEL token owns 0.25% of the earning redistribution.
So, how much is the value of 1M $YEL?
If we apply the rules we used for the house, a safe investor wants to get all his money back in 20 years (P/E = 20).
If only we knew how much total revenue will generate Yel Protocol in a year, we could take 0.25% of that value: this would be how much earning would get 1M $YEL of redistribution in one year — since we said that 1M $YEL gets minimum 0.25% of the earnings.
Once we know the earnings (rent) generated in one year we just need to know how risky $YEL will be: if it is safe a safe investor will be happy to pay 20 times the revenues for that but the more it is risky it is perceived the less the safe investor will want to pay for the same revenues. Just like the house.
All this translates in an APR on the staking pool; let's see specifically how this happens on a DeFi token.
Self stabilizing APR loop
The APR on the staking pool, the risk and the price of the token are all bound together in a loop. Let's see one example of this loop.
We start from a balanced situation: the perceived risk of the token is (for example) 25% APR. People agree to invest on the token because they get their money back in 4 years.
Imagine then all of a sudden the protocol double the earnings: all the $YEL into the staking pool now will get double the earning: the APR is now 50% (2x 25%).
APR 50% means that people will get their money back in two years, for a token that has not changed risk level. What do you think it will happen?
It will happen that more people will buy $YEL on the market to enter the staking pool, hence increasing the token price; moreover more people on the staking pool will dilute the revenues per token: decreasing the pool APR.
If nothing else changes the APR will slowly get back to the original 25%, increasing the token price as a side effect.
Another example is the change of risk: more components get deployed and tested in a project, the more audits gets done, the more reputation the projects takes the less risk perceived it has.
So if we start with a risk perceived that is compatible with 25% APR, if the risk gets lower with the time the target APR will get lower too (keeping fixed the earnings people will agree to have their money back in five or six years instead of four because the risk is less).
Now if there are people willing to accept a risk of 20% on $YEL but the APY is still 25% they will buy $YEL on the market and deposit them, until again the price rise and the APR drops to the target 20%.
This is how a token price is moved by perceived risk and revenues shared.
Studying $YEL
Let's do some math and some comparison to get an idea of the project value.
Perceived risk — APR
First assumption to make: how much will be the perceived risk of Yel.finance?
At what level of APR will it stabilize?
We have to make some assumptions here: risky bonds are around 8% APR,
Harvest’s APY on their staking pool is 24%
Sushi’s APR on their staking pool is 15%.
You can compare many projects and make some assumptions: I think when $YEL will be all deployed and running will go under 30%. Let’s say 3x a risky bond: 24%, similar to harvest.finance.
Token supply
$YEL will have a total supply of 400M, but not all of them will participate in the staking pools. Let’s say only 300M (not considering that there may be a burn of some tens million in the future).
TVL — Total Value Locked (deposited) on the service
Now the hard part: how much TVL will Yel get on Equilibrium?
We need it to calculate the fees generated by the protocol.
No one knows how much it will be, but we can again compare to similar project, considering that Yel is innovative and will resemble and ETF switching and investing on many farms all across DeFi, with only the selection of the risk level.
Yel is in the category of protocols where one can deposit values to see them grow and invested: "assets" on DeFi Pulse:
There are 36 projects in that category, the top 3 are all in the Billions TVL, medium ones are in the hundred of millions:
Usually the new innovative protocols go in the top part of the chart, their clones in the middle.
At the time of writing the total TVL on the Assets category is $23,395M, divided by the 36 protocols we have $650M.
Let's make it conservative and assume a TVL of $400M, like Harvest, that is a great project but just a clone of one of the top three.
TVL distribution in the pools
Total TVL is not enough because there will be three pools with different risk levels — an you now know that risk levels are APR levels.
This is really a shot in the blank until we have more data: let's say half the TVL will go in the low risk pool, then 35% on the medium and 15% on higher:
APY on the pools
From this official document we can see the actual APY for the many pools in Equilibrium:
The average APY for Safe level is 89%, the average APY for Medium level is 134%, the average APY for Risky level is 40,000%.
To be more conservative in our estimation we will lower those numbers: we will use 20% for safe, 120% for medium and 5,000% for risky. If they will be more than that we cannot but be happy:
APY to APR
Now we just convert APY to APR because APR is easier to make math with.
Calculate monthly earnings
Equilibrium takes 15% of earning as protocol fees.
For the medium pool risk in our study we have 140M deposited (35% of 400M), these will have on average 78.39% APR each year. To get the monthly Earnings we have to divide by 12.
Those will be $9,208,500.00 each month, protocol will take 15% that is 1,381,000.00 of fees.
Repeat all this numbers for all levels and we have:
Total Earnings
Now we sum up all the fees of all the pools and we have an annual total earning of more than $57M, divide that by all the tokens on stake (300M) and we have the dividends per single token: $0.19.
This is the earnings of $YEL token in year, with the above-mentioned hypotheses.
Computing risk
If we take for true the 24% APR of the staking pool, then going from the single token earnings to the token price is a matter of dividing the earnings by the APR: in this example it is $0.80.
This considering only Equilibrium, but there will be other services that will contribute to the earnings: a lottery, a bridge, and more.
Final considerations
No one knows the risk level and the final TVL Yel.finance will have.
In this study we only used Equilibrium as a mean to generate revenues, but there will more: a lottery, a bridge, etc.
As an exercise we can see what happens when we keep fixed the risk and increment TVL, or what when we keep the TVL fixed and lower the risk.
Here we are assuming Yel.finance will have 2B TVL: not changing anything else the price goes to $4.00.
Here we get back on 400M TVL but we lowered the risk to 12% APR: price goes to $1.60.
Final assumptions: 2B TVL and 12% risk: $8.00.
These numbers are net of general market benchmark: DeFi is expected to grow 80%/year the next years, but there will be a corrections and nobody knows the future. We know math though, and we can make reasonable assumptions.
Obligatory reminder that these are not financial advise and you should invest only what it is comfortable for you to lose — especially in DeFi.
Hi, I’m -DvD-. I’m a mod in the Yel.finance Discord — this is why I invested on Yel.finance. Being on that Discord I realized which are the most misunderstood concepts of DeFi and here I try to simplify them.
I believe that knowledge should be free and accessible for all, but if you wish to offer me whatever beverage is good in your culture you can tip me at: 0xebDBbca4744C66E3aE39F997fD5fB7dE29874ce5, I’ll be super happy to know I helped someone! Cheers!
