Where do Crypto Yields Come From?
The concept of yield farming in crypto refers to the practice of lending out your crypto assets to earn interest on them. This can be done through a variety of different platforms and protocols, including lending platforms, staking platforms, liquidity pools, and even through some smart contracts.
In general, yield farming refers to the practice of earning interest on your crypto assets by lending them out or staking them. This is a great way to earn passive income on your crypto holdings, and it can also help you to grow your portfolio.
Where do crypto yields come from?
Yield can be generated through a variety of different means such as trading fees, lending, and borrowing fees, smart contracts (strategies-Yearn), protocol fees, and reward programs. Below, we break down the ways crypto generates yield and explain the potential caveats for participating in each:
Trading fees APY (DEX)
A decentralized exchange (DEX) is a type of cryptocurrency exchange where buyers and sellers trade directly with one another, through liquidity pools, without the need for a third-party or centralized authority. These exchanges are peer-to-peer, meaning that all transactions are verified and stored on a public blockchain, allowing for greater transparency and security. DEXs are often more secure than centralized exchanges and less prone to bank runs, like what we have recently seen with the entire FTX fiasco.
Liquidity providers, who are often the driving force behind a DEX, earn trading fees for lending their tokens out for others to swap. This is done by providing liquidity to an order book or liquidity pool, which allows traders to buy and sell tokens quickly and easily. Liquidity providers are compensated for their efforts by receiving a portion of the trading fees generated from each exchange transaction. This incentivizes liquidity providers to keep their tokens available for swapping, which helps to ensure the liquidity needed for smooth and efficient trading.
Below you can see the TVL, 24h volume, and the 24h fees generated through the USDC/ETH liquidity pool on Uniswap. All of these fees are going directly toward the liquidity providers:
Providing liquidity carries a risk of the liquidity provider experiencing impermanent loss. Impermanent loss occurs when the price of the asset being provided as liquidity moves away from the price at which the liquidity provider entered the market. This can lead to the liquidity provider experiencing losses, even if they close their position.
These losses can be compounded if the liquidity provider is providing liquidity on multiple assets at the same time, as the impermanent loss on one asset could offset the gains on another. In addition, providing liquidity can also carry a risk of slippage, which can occur when the liquidity provider is trading in a highly volatile market. Slippage happens when the market moves so quickly that the liquidity provider’s orders are filled at a worse price than expected, resulting in a loss of potential profits.
Lending fees APY
A decentralized pool-based cryptocurrency lending and borrowing protocol operate by allowing users to borrow and lend digital assets from a shared pool of assets. The protocol uses smart contracts to facilitate the loan and borrowing process and ensure that the terms of the loan are met. All loans are stored in the shared pool and are accessible to all users. The protocol is designed to ensure that all transactions are secure and transparent, giving users the confidence to make loans and borrow money.
Users are able to participate solely in the lending side of the protocol and earn an APY, thus not exposing themselves to any risk by borrowing against their assets. For example, you could lend out USDT on AAVE and earn 2.23% APY without taking on a loan:
Protocol fees APY
Some protocols opt to share revenue with their users. Sushiswap, for example, charges a 0.3% fee for all trading pairs, with liquidity providers receiving 0.25% and xSUSHI token holders receiving the remaining 0.05%.
Once MELD starts to generate revenue, a small percentage, similar to Sushiswap will be allocated for MELD stakers. Stay tuned!
Strategies (Yearn)
Yearn Finance uses a variety of strategies to maximize profits for its users. These include the use of automated portfolio rebalancing and dynamic vault strategies which use yield farming, arbitrage, and lending to generate returns. The platform also employs a liquidity mining program that rewards users for providing liquidity to the platform’s pools. Yearn has integrated a range of DeFi protocols and platforms in order to gain exposure to a variety of investments and optimize returns.
For example, the Yearn USDT Vault (4.84% APY) has 3 different strategies attached to it:
Reward Programs
One of the final ways crypto yields are generated is through reward programs. These are simply a protocol, or partner, offering some token (usually their own) as a reward for participating in the position. This is done to incentives users to move their liquidity.
MELD staking, for example, offers stakers MELD tokens for staking MELD for 6 or 12 months. This will eventually be attached to protocol fees in the future!
Another example of a rewards program is with our partners; Wingriders:
This position offers liquidity providers of the ADA/MELD liquidity pool with WRT tokens — currently earning ~29.4% APY broken down below:
Pool Fees APR: 2.926 %
Pool Staking APR: 2.446 %
Farm APR: 5.044 %
Boosting APR: 18.978 %
Cryptocurrency vs. Bank Yields
Banks use customers’ liquidity to generate yield by investing it in different financial instruments, such as bonds, stocks, and other investments. The bank then collects a return on those investments, which is ultimately the yield they earn. However, banks generally provide very little back to the initial liquidity provider, as the returns they receive on their investments are typically much higher than the interest they pay back to the depositors. This allows them to keep most of the profits they generate from the customers’ funds.
These players are fundamentally against DeFi because the majority of these yields, in DeFi, go directly to the user supplying the money, rather than the middlemen. This means that the banks are not able to make as much money from their customers’ money. As a result, they are less willing to support DeFi projects.
There is a large wall between these centralized players and DeFi and it should be interesting to see how the gap shrinks over time.
Conclusion
If you have any thoughts/comments on yield farming, or just want to start a discussion with one of our community members or ambassadors on this topic, come join our Discord and start the conversation!
MELD — Be Your Own Bank
We think it’s essential for everyone to gain control of their financial lives and have equal access to financial instruments used by professionals, not just centralized institutions, governments, or the 1%. We want to provide financial freedom and control to the masses, including the unbanked.
We have a long-term goal to enable the $15 trillion that is currently locked out of the global economy, including 2 billion individuals worldwide that are either underbanked or have no access to banking services whatsoever, access to these tools. These are the people that are paying the highest fees, and getting the worst customer service, and they are the ones that are having the most problems.
Our vision is to create an ecosystem that empowers individuals to regain financial control by providing them with the tools and services they need to manage their money on their terms. Whether that be creating a collateralized debt position (CDP) with cryptocurrency, earning an interest return for lending fiat to borrowers, or even participating in reward incentive programs, we strive to provide our users with the functions they need to manage their own financial lives.
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