The DeFi agricultural revolution

Dear Crypto Enthusiasts:

The DeFi ecosystem is literally going through the roof.

While the world is heading to the worst economic recession of the century,

Projection of the world’s GDP contraction range between -12 and -14%. Estimates from OECD.

DeFi reaches the milestone of USD 2.8b total value locked and growing by the minute. Not only this figure is an All-Time High figure, but more importantly, is growing exponentially:Total value locked in the system increased 2x in the last month!

Exponential growth of total value locked in DeFi: Source: DeFi Pulse

What is happening here?

The hyperbolic growth curve was triggered by the announcement last month of Compound, a permissionless borrowing and lending platform, to issue and distribute a new governance token (COMP) through a novel incentive mechanism called liquidity mining or more colloquially, yield farming.

Yield farming is a novel incentivization tool for bootstrapping communities and markets of emerging platforms. It rewards active users who provide value to a network with political rights to decide on future protocol updates, and sometimes economic rights, such as cash flows or other value accrual mechanisms.

Other projects like Uniswap, a decentralized exchange and automated market maker (AMM), and Synthetix, a DeFi derivative protocol, pioneered yield farming in the DeFi ecosystem. However, it was the announcement of Compound program last month which brought the topic to the headlines. In Compound’s program, a new governance token, COMP, is freshly minted and distributed to users who actively provide value to the system.
In this program, tokens go to liquidity providers. Although it is now possible to acquire the COMP token in decentralized exchanges like Uniswap, the idea is that users can “earn” the token by participating actively in the protocol.

COMP rewards for liquidity providers. Source: https://compound.finance/governance/comp

This distribution of the governance token is added to the accrual of interest rates for depositing or lending funds to the protocol.

This novel incentive mechanism is an implementation of the SAFG model (Simple Agreement for Future Governance), which is an iteration of Y Combinator’s SAFTE model. In the SAFG model, people who participate in the protocol earn governance tokens that can eventually be used to vote on protocol changes.

The COMP token had by design no economic rights attached (v.gr. cash flows or other value accrual mechanisms), but only political rights (voting in future protocol changes). However, the speculation that COMP token holders can in the future vote for implementing value accrual mechanisms, threw the price of the COMP token through the roof.

$COMP price evolution since ist first issuance in the 20th of June. After a sharp spike, price has somewhat stabilized but it is still regarded by many analysts to be overvalued. Source: Coinmarketcap

Users rushed in to provide liquidity to the network, increasing value locked by 6x in only 1 month!

Total value locked in the Compound protocol. Source: DeFi Pulse

As its name “liquidity mining” implies, this framework alludes to the original Bitcoin incentive structure, where users who provide value to the network (v.gr. providing security) are rewarded with freshly minted coins of the network. Is a form of incentivizing active community involvement in the growth of the protocol. Is a way of subsidizing the supply side of a two-side money market.

Imagine for a moment you were an early user of the google search machine in the 1990s and you were rewarded with Google shares! Interesting, right? Something similar happens with liquidity mining. Early users are rewarded with a share of the network. The difference now is that only active users who provide value to the network are rewarded, and if they are passive they will get diluted with time.

For users, liquidity mining has become a very profitable passive income opportunity. We have seen in the last weeks' annual percentage yields (APY) in excess of 100%, which has attracted many additional investors into the space. Calculate here the expected COMP rewards! Beware of the risks!

Since the COMP announcement, more and more complex and profitable yield emerging opportunities have emerged. Protocols such as Synthetix (synthetic and derivative asset platform) Balancer (automated market maker, and fund management), Curve (decentralized exchange) and Futureswap (futures) have implemented similar and more complex programs for incentivizing liquidity providers in diverse platforms simultaneously. We expect that all DeFi protocols will implement some variation of liquidity mining to reward active users who actually use the protocols and provide them with liquidity. The interaction of different protocols also brings additional earning opportunities but also risks to the table.

Risks

Generally speaking, as in traditional finance, the higher the yield, the higher the risk. And like in the rest of the DeFi ecosystem, risks are still not yet fully understood and uncovered. Please be diligent and take into account that this is still experimental technology! The most important recognized until now are Smart contract risk, Platform risk, Oracle risk, Exchange rate risk, and black swan events.

Smart contract risk is the most common risk in DeFi protocols. The technology is new and code could have bugs and vulnerabilities that can be exploited. One way to mitigate this risk is to acquire a smart contract insurance by Nexus Mutual.

Platform risk: Refers to the systemic risk of the Ethereum platform as a whole.

Exchange & liquidation risk: Cryptoassets are very volatile. If the value of the collateral uses for borrowing suffers a sudden drop, the smart contract can liquidate the position, which can lead to a partial or total loss of funds.

Oracle Risk: Oracles are priced feeds that use data from the outside world. They have always centralization points and could be manipulated. Chainlink has adopted solutions widely used in the DeFi ecosystem that can minimize these risks.

Black swan risk: In the market crash in March, prices fell >40% in a single day. Due to the uncertain global economic situations, unforeseen vents can not be discarded.

Resources

If you want to learn more about liquidity mining and yield farming, we recommend:

Bankless. Best DeFi resource out there. Newsletter, Podcast and DeFi community

Newsletter daily Gwei by Anthony Sassano

The DeFier: Newsletter by Camila Russo

Blue Swan Academy offers webinars and online workshops on demand to train individuals and businesses to use decentralized finance tools. The educational offers are entry-level, with no previous knowledge required. We believe in “learning by doing”, so you will learn to use the most important protocols and applications. Please check out here our current offering. and sign up for our newsletter.

Blue Swan Academy is an educational platform for blockchain powered economies, focused on the legal and financial industries.

Author: Juan Escallon

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Head Blockchain Academy at Blue Swan. Blockchain Law. Decentralized Finance. Online training

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Juan Escallon

Juan Escallon

Head Blockchain Academy at Blue Swan. Blockchain Law. Decentralized Finance. Online training

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