High Yields in Cryptocurrency — Explained

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Coinmonks

9 min readFeb 24, 2022

Once you’ve had a taste of the rollercoaster-like volatility in cryptocurrencies, you may begin to seek for a means of securing stable returns without going through crazy ups and downs in trading. Earning yields from staking crypto assets, as a result, is incredibly appealing to investors.

Without opening a decentralized wallet, you can access high yields by staking your cryptocurrencies on a variety of platforms. For instance, BlockFi, one of the leading institutions providing crypto lending & borrowing services, now offers a yield as high as 9.25% APYs ( Monthly compound interest ) for staking USDTs.

In comparison, the return rate of depositing the US dollar into a US bank account remains below 0.5%. In a time inflation is hitting four-decades high, consumer prices index (CPI) in January soaring up to 7.5% year over year, putting money into a traditional saving account would naturally dilute one’s purchasing power.

In Decentralized Finance (DeFi), the yield sometimes could be jaw-dropping. The most attention-capturing way of earning yield is called liquidity mining, where APYs as high as 1000% or even 10000% are offered by some rising decentralized protocols.

Supposedly, you can 10x or 100x your money by simply depositing a pair of tokens — usually constituted of a newly minted token and a mainstream token like ETH, DOT, USDC — into a liquidity pool for a year or so.

It does seem too good to be true, right?

Before we dive into the the high yields generated in crypto, we may have to first understand how yield works in the traditional finance.

What’s Yield?

According to Investopedia, yield refers to the return that an investor receives from an investment such as a stock or a bond. The most common way to earn yields may come from the US government-issued treasuries, which are regarded as risk free — since they’re backed by the full faith and credit of the United States government, which has never defaulted on its debts

Today, the 10-year Treasury yield sits at around 1.92%, meaning that if you investing $100 on the treasury note, you will have $101.92 in return. Investors get paid with interest every six months, and gain the face value at maturity.

The yield changes almost constantly along with the demands of bonds. That’s because a bond’s price is inversely related to yield: When demand is high and Treasury prices rise, yields fall — conversely, when demand is low Treasury prices fall and yields rise.

The 10-year Treasury yield serves as a vital economic benchmark. It is often impacted by a number of factors, such as the market condition, the overall economic strength, and, most importantly, the benchmark interest rate set by the Federal Reserve. As the economy boosts, interest rate tends to hike up and thus borrowing money requires a higher cost, so equities tend to trend down. Investors choose to go after “risk-free” assets like the 10-years treasury note.

For instance, the yield plummeted to an all-time lows of 0.54% on March 9th, 2020 due to the outbreak of the pandemic; almost two years later, as the Fed is expected to hike rates, at least, four times in 2022, the yield, in consequence, has been soaring and now floating in between 1.9% — 2%.

When the crypto winter kicks in, the demands for stablecoins rise and investors avoid risky assets like altcoins. And as investors stay away from leverage trading, less stablecoins being borrowed for longing BTC and other cryptocurrencies, the yields offered for lending stablecoins decreases accordingly.

Crypto Yields

Nowadays, most crypto companies operate like banks for digital assets. They provide customers with digital wallets, crypto saving accounts, and services like borrowing and lending cryptocurrencies.

Celsius Network, a crypto loan company whose managed asset quadrupled last year to 25 billions, offers up to 17.85% yield for staking SNX, the token of Synthetix Network. Staking stablecoins like USDT or USDC on its platform can earn you a yield more than 10%; for BTC and ETH, the yields could still be around 4–5%. Celsius pays yields in either CEL, the home token of Celsius, or in the staked tokens, with the former one offering a much higher return rate.

In earlier February, BlockFi paid 100 millions dollars in total to settle a dispute regarding of “selling unregistered securities” with the SEC and various states in the US. Regulators accused BlockFi of offering unregistered products that pay customers high yields for lending out digital assets.

Based on the agreement with the regulators, BlockFi would stop accepting new American customers for yield-earning accounts. Meanwhile, the firm defended its business practices, claiming that high-interest returns could be offered because institutional investors continue to borrow assets from them through even a higher rate.

That whether cryptocurrencies should be treated as securities continues to cause controversy, as more businesses are trying to be structured as crypto banks. The concern of high yields being offered by crypto firms doesn’t stop there.

When asked how Celsius gets to outcompete not only the traditional banks but also other fintech giants by offering high yields for investors, Alex Mashinsky, the found & CEO of Celsius, commented on multiple occasions that the company lended out digital assets to leverage traders and made a profit out of the interest difference in between staking and lending.

He further elaborated that the reason banks offer such a low interest for their clients because they had been ripping then off. Basically, he believed that Clesius is a game changer mostly because the firm prioritizes its customers, other than its profit margin.

However, a recent Bloomberg article revealed that “Celsius has invested hundreds of millions of dollars of customer funds through DeFi protocols” through a source from a former employee of the company. Celsius admitted in December that the company had lost $54 million in a DeFi hack but no user assets were affected.

Crypto companies able to offer double-digit yields for deposited assets may be attributed to the lack of transparency and the relative looseness from the regulatory side. At the end of the day, though, it all depends on how much risk one could bear for gaining high returns. One may ask: why wouldn’t one simply deposit money straight into DeFi protocols, if that’s the way how crypto firms earn their high yields?

Yields in DeFi

Defi is the gold-digging wild west where big money is being made. You may lose everything in yield farming if you unfortunately get rug pulled. Or you may double your positions within hours when being the early liquidity providers to unknown pools.

High risk, high reward.

Fundamentally, there are three ways of earning yields through DeFi.

Lending.

People pay you interest to borrow your crypto for making leveraged investments of their own. This could be done through protocols like AAve, Compound, and more. You deposit your money like you would on centralized crypto firms. The distinction, though, is the absence of intermediaries that take a profit out of the interest difference. You earn yields by lending assets to other DeFi users.

2. Staking.

This is an incentive mechanism implemented by proof-of-stake networks like Ethereum, Olympus, and Terra to validate transactions and secure network stability. Users staking a specific amount of tokens on blockchains are eligible to be “validators” who validate each block of transactions. In return, they earn the transaction fees as rewards in the same type of tokens they staked on the blockchain. In essence, The coin owners offer their coins as collateral for the chance to validate blocks.

To be a validator of the Ethereum Blockchain requires a minimal holding of 32 ETH

3. Yield Farming.

This is where the most amount of yield is earned or lost. As I’ve written previously, under the AMM (Autonomous Market Maker) model, liquidity providers stake a pair of tokens in a specific pool to earn transaction fees. The rewards are paid by one of the staked tokens.

Usually, the pair that comprises of mainstream tokens is rewarded much less than the other newly issued tokens. Liquidity mining is a crucial way for a token issuer to reward whoever is willing to stake and hold the newly issued token.

For instance, SPECTREFI, a farm built on Fantom Network, has its native token, SPECT, available to be mined. As of the publication time, wth the max supply up to 3000 SPECT token, only 50 of them is the initial supply. Less than 2% of the tokens were available on the market.

However, the total locked value has gone up to more than 1.16 millions, meaning that many people are willing to provide liquidities and earn rewards in SPECT tokens.

Why? Because they 1)believe the value of the token will go up and 2)the APRs of the pools are extremely high.

So… when platforms dish out insane APRs by minting tons of their tokens to create hypes, the APRs end up not keeping pace with massive inflation caused by a surge of supply, and the tokens devalue quickly.

If one deposits the equal value of Fantom Token and SPECT token — as a liquidity pair — to the pool for a year, one can gain a yield nearly 4000%. That's insane, right? The sketchiness is that one has to bear the risk, despite the 0% deposit fee, of SPECT enormously depreciated and the high impermanent loss. There is huge uncertainty involved, since the initial supply of the native token only accounts for 0.06% of the total supply.

Additionally, rug pull is a major risk of yield farming. Anyone simply adjusting a few lines of codes can create a farm whose yield is given in its native token. So, he could also steal all of your deposited assets by shutting down the whole farm. You may lose all you have due to your trust on an unknown entity.

Whenever you see a platform offering huge APRs, the value of their tokens are likely to drop precipitously once the weight of selling rewards overtakes the demand for the tokens. The game plan thus is to constantly get new people into the gold rush, until the hype becomes unsustainable. The price drop then could be truly catastrophic, where you see tokens lose 99% of the value within hours. People joining these “farms” are mostly betting to be the early sellers when the demand is still somewhat sustainable and not to be the ones who get dumped on.

Does it sound like a pump-and-dump scheme you often see in penny stocks? Yes. They belong to the same play book, though executed differently.

Despite all the scam-like qualities in some of the yield farming protocols, liquidity pools are crucial for bootstrapping adoption of a new token, with the prerequisite that the distribution of a token isn’t so aggressive that it outpaces the demand. Overall, liquidity mining democratizes the process of tokens being issued, and equips anyone with the opportunity to mint, promote, and monetize a native token akin to a specific project.

Risk and Reward

There is no free lunch in the world, and the crypto space may be the last place where you find an exception.

When evaluating DeFi projects offering attractive APRs, it’s important to figure out where the yields are coming from. Can the platform fees being redistributed to token holders sustain such a high yield? If not, then it may have been the platform intentionally inflating its token, hoping that more people are willing to buy it and keep pumping it up.

Stay alert and stay cautious.

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High Yields in Cryptocurrency — Explained

What’s Yield?

Crypto Yields

Yields in DeFi

Risk and Reward

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Written by Jay Zhuang