Where Do Crypto Yields Come From?

Quincy Ememandu
Coinmonks
4 min readMar 21, 2022

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Are they sustainable?

Crypto Yield

A good Investor would ask this question “How do DeFi protocols generate yields?”

You must have been in several crypto groups and social media platforms, especially amongst newbies, where they ask this question.

“Where does Crypto yield come from?”

The higher the APY, the more serious the question.

Where do they generate the yield for those with high APY ranging from 200% and above?

DeFi protocols are the crypto version of our traditional banks. They offer various yield farming opportunities for investors.

DeFi protocols like AAVE, Pancakeswap, Curve, Compound, etc., which have stood the test of time, are now a go-to place for investors. New projects now spring up with high and risky APY to entice new investors.

You must understand that it is normal to have high APY when a project launches newly because few investors share the yield generated. But when it begins to have more investors, it will reduce drastically to a more sustainable percentage.

So today, I will enlighten you about where these DeFi protocols get the yields they pay their investors.

You will also know when a DeFi protocol is a Ponzi scheme parading itself as a DeFi protocol.

Where do DeFi protocols generate the yield they pay their users?

  1. Providing Liquidity.
  2. Exchanging risk.
  3. Distributing equity.
  4. Natural demand for borrowing.

Providing Liquidity:

A man providing liquidity into a pool

A liquidity provider provides his crypto assets to a platform to help decentralise trading. They are rewarded with fees generated by trades on that platform, which can be considered passive income.

To provide liquidity, there has to be a pair. Imagine I want to provide liquidity on a DeFi protocol like Uniswap; I will buy ETH and LINK and add them into the Uniswap ETH/LINK liquidity pool.

People who buy ETH/LINK on Uniswap are charged a transaction fee of 0.3% on each trade.

This transaction from the trading fee is shared evenly among liquidity providers of ETH/LINK to incentivise them for providing their crypto assets.

Exchanging risk:

What is your risk appetite?

People have different risk appetites. You can take high risks and feel normal about it, while someone else can take on minor risks and have sleepless nights over them. Imagine Desmond bought a car and is willing to pay an insurance company to protect his vehicle if it gets stolen or has an accident.

An exchange risk has occurred. The insurance company is willing to take the risk and get paid for it, and Desmond is willing to pay anyone who can bear this risk for him.

In the DeFi space, Saffron finance allows users to provide liquidity according to their risk appetite. Saffron finance has three different user-facing tranches.

AA Tranche: LPs(liquidity Providers)adding to this tranche earn less interest, but in return, In the event of platform risk and loss, principals are protected.

A Tranche: LPs adding in this tranche earn more interest but lose part or all their capital and interest in the case of platform risk.

S Tranche: LPs in this tranche balance with the AA and A tranche to maintain equilibrium regarding the tranche interest rate multiplier.

Distributing equity:

Distributing equity.

In 2020, Uniswap gave 400 UNI to its community who had interacted with their protocol, provided liquidity and added value to their protocol. The equity that could have been sold as ICO and used to support the project was free to its community.

This is also a form in which DeFi protocols generate yields by distributing its token to users who add value to its protocol.

Natural demand for borrowing:

Natural demand for borrowing

People borrow money to solve problems, sponsor projects, or buy assets. Businesses borrow to support their company when necessary; banks borrow to meet the reserved requirements; individuals borrow to build a house, pay school fees, etc.

In the DeFi space, people explore the opportunities of being able to access a pool of funds with low-interest rates to leverage without passing through strenuous systems.

When money is borrowed from DeFi protocols, interest rates are paid and are used to keep the protocol running.

With this information, you should discern which DeFi protocol is camouflaging as a Ponzi Scheme waiting to explode with invested funds from sustainable DeFi protocols.

Quincy is a Crypto Researcher and Writer, passionate about educating people about Crypto. He is also a Technical, and Twitter thread Writer.

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Quincy Ememandu
Coinmonks

I help Web3 projects create awareness and attract users to their project | Content Marketer | Reach out to me via qememandu@gmail.com