YFI — Reborn As A Black Hole
Disclosure: The author of this report and associated parties hold YFI tokens and may hold associated derivatives. These statements are not a recommendation to purchase any token or invest any funds. You should do your own, thorough research before investing a cent in any market. This is not financial advice, investment advice, or advice of any sort.
TL:DR
- Yearn is likely to undergo massive tokenomics changes
- Yearn is an OG DeFi protocol with one of the best products, cultures, and teams in the space
- Yearn is about to incentivize token migration from weak to strong hands
- YFI currently trades at a very low 11.82 P/E and 5.54 P/S. (As mentioned in our Convex piece, Silicon Valley FinTech VCs would literally knife each other to invest in projects at these prices)
- With no inflation, YFI treasury buybacks have no offsetting supply to meet this new demand — ie “number goes up”
- Adding Gauges to Yearn Vaults adds the possibility of a secondary income stream to token holders in the form of voting incentives, further adding value to YFI tokens
In The Beginning
From the moment of its fair launch birth, Yearn has been one of the most captivating names in DeFi. With no inflation and a rapidly growing TVL, YFI tokens were impressive performers out of the gate. However, aside from the short lived run to $90k that came with the Yearn team’s late foray into the realm of dog coins under the thinly veiled disguise of a unit bias test, YFI token performance has left much to be desired. So much so that we’ve jokingly referred to Yearn as a stablecoin in one of our more satirical writings.
From where we sit, we see three main reasons as to why YFI has underperformed for the majority of this year.
- While TVL has been building, the growth rate in revenue has been somewhat weak
- Although Yearn has looked cheap on many Tradfi Metrics such as Price:Sales and Price:Earnings, a value accrual mechanism to token holders had remained elusive
- Yearn likely suffered from the the effects of having a measurable product (an infinite valuation can be justified for a product which can’t be measued/does not exist (cough, Cardano, cough) and a lack of token incentives to attract YFI token buyers via mercenary farming capital.
We’ve known for some time that changes which would address the above concerns were on the way, but we didn’t know Wen. This week, all of that changed with 2 important actions. How many realize it? The answer is simple: Few.
A Brief History
The recently proposed tokenomic changes are going to turn Yearn into a black hole for its own tokens, massively rewarding token holders and governance participators through what looks to be an incredibly strong flywheel built to reallocate tokens from the paper handed to the true believers. But, before we dive into the why and how of the above, we should discuss the foundations upon which this system has been built.
Yearn was originally an Andre Cronje project. In what has been lauded as one of the most truly fair launches, Andre airdropped the entire supply of YFI tokens to users and sat back to watch what Mother DeFi Nature would do. A team quickly formed around the project, for which Andre has professed much respect. “The yearn team is far more skilled and capable than I am, and anyone that thinks yearn is dictated, led, or in anyway dependent on me, is doing yearn a disservice. I am happy to be a contributor to something much bigger,” he said.
This fair launch has been a double edged sword for Yearn. Having no tokens allocated to the treasury to help support protocol growth was ultimately addressed with a governance proposal which expanded total supply by 20%, with 1/3 of the new tokens allocated as rewards for contributors and the other 2/3 going to the treasury.
The benefits of the fair launch seem to have far outweighed the drawbacks. Yearn has remained one of the most truly decentralized projects in the space, and I have no doubt that 10 years from now HBS will write white papers about how Yearn was on the cutting edge of DAO evolution and governance precedent.
Yearn has also built one of the strongest teams in DeFi, led by some of the strongest devs in the space. Banteg and Tracheopteryx have routinely come to the aid of protocols in need, helping to fix bugs or patch security holes, all in the name of community and a rising tide of DeFi.
While The Blue Pill (full text in hyperlink) may be slightly up its own ass, it is a strong and inspiring testament to the creativity, vision, mission, and morals driving the Yearn team. More than just a lavishly illustrated backstory, The Blue Pill is quite literally a call to anyone and everyone to join the Yearn community as a contributor. A more pristine and utopian vision of the new, decentralized world can’t be found. It is well worth your time to view the entire text.
Proposed Tokenomics Changes
Under a current governance proposal which we expect to pass, 4 tokenomics revisions stages have been laid out. Each of these revisions must be implemented in order, but it is not necessary that they ALL be implemented. They are also concisely explained in this thread by 0xJiji
Yearn has already begun to use protocol fees accrued to the treasury to purchase YFI tokens from the market. These tokens will be used to reward YFI stakers under an xYFI model, which is stage 1 of the tokenomics revisions. This finally addresses the criticism surrounding a lack of value accrual to token holders, but this is only the beginning.
Stage 2 introduces a Curve-esque vote escrow model, wherein YFI token holders are incentivized with rewards in exchange for locking their tokens, with rewards increasing with the amount of time that tokens are locked.
Stage 3 introduces Vault Gauges. These gauges allocate rewards on a vote based system, and introduce the likelihood that veYFI token holders may earn external voting incentives, similar to how protocols are currently incentivizing vlCVX token holders through a platform like Votium, to vote for Curve Gauges of their choice.
Stage 4 allows veYFI holders to earn even more rewards for “useful work” or contributing.
In The End, It All Comes Down To Supply & Demand
We’ve discussed how YFI is about to implement changes that accrue value to token holders, not just the protocol treasury. But what we haven’t discussed is how Yearn is different from almost every other DeFi protocol. This key difference is due to the fact that almost all of Yearn’s tokens are in its circulating supply. Inflation for YFI tokens is close to 0.
Most protocols issue rewards through inflationary tokenomics. The most common protocol model involves issuing rewards for capital allocations and governance participation, as well as longer vesting periods for team allocated tokens. As the typical protocol grows, this growth invites demand for its tokens, but this is offset by the increasing supply that comes from tokens issued as rewards. If protocols don’t grow their platform metrics faster than their token inflation, the token price can drop even as the market cap of the project increases.
Because Yearn has almost no inflation, there is almost no supply to counteract the purchasing demand from the treasury. As Yearn earns more revenue, more tokens will be purchased from the market and allocated to those most likely to hold and lock these tokens, thereby reducing available supply. When buying pressure, aka demand, remains constant while supply shrinks, the market will naturally move towards higher prices as it seeks a balance.
We have seen this supply and demand imbalance drive prices higher in the ILV token, which incentivizes stakers to lock for 12 months, and requires ALL rewards to vest for 12 months from the date they are claimed. These factors have resulted in a continued decrease in available ILV tokens as more and more tokens are locked but no new supply is coming to meet demand. Aside from the tailwinds in the gaming space, we believe that this shrinking available token supply has produced steady upward pressure on ILV prices.
Add to this the fact that there is strong precedent for incentivizing voters who direct the rewards of DeFi protocols, this likely second income stream to veYFI token holders will only add more demand for tokens as their total yield increases beyond “just” the staking rewards. As Convex grows beyond simply being a Curve symbiote, it is not far fetched to envision a cvxYFI token, which gives veYFI token holders liquidity and the ability to demand voting incentives from protocols utilizing YFI Vaults.
We’ve seen Convex Finance rally more than 4x in the last 4 months, mainly driven by these secondary voting incentives. (Our Convex piece laid out the framework for why Convex was undervalued and why it was on the precipice of a rally before the 4x move.) Imagine what the combined power of diminishing supply dynamics and secondary voting incentives could do to what is already an inexpensive YFI token as measured by any traditional metrics.
The train is quite literally leaving the station as I write this. It may take some time for momentum to build, but if this proposal passes, YFI has a clear pathway to rapid value appreciation driven by value accrual and simple supply and demand market dynamics. Are you ready to take The Blue Pill?
Special thanks to 0xJiji and Adam Cochran for their concise twitter threads, as well as to Banteg and Tracheopteryx for being totally awesome.
