Crypto For Kids Series by Double Rainbow Crypto
How Does APY Work in Defi?
The story of Larry, his pickles, and a whale named Whaley
A Simple Proposal
Larry is a world-renowned pickle farmer who is looking to raise some money for a new pickle farm.
“I have enough pickles to give out 100 every day (emission rate). Perhaps my friends will loan me some money in exchange for daily pickles. I’ll split the pickles up between my friends based on how much money they loan me — But I can only give away 100 pickles every day.”
Larry reaches out to all his friends to tell them about his idea.
Launch Date
The next day, ten of Larry’s friends who had heard about the deal arrive at his door. Having reviewed Larry’s proposal, they each decide to loan him exactly $100. Larry now has $1,000 (total value locked). In exchange, they each are given ten pickles because they each supplied 10% (pool share) of the total. They head to the market to sell the pickles.
“Today pickles are selling for $1 each (market price).” one exclaims.
“We each made $10 today (daily earnings)!” another adds.
“That means in ten days, we’ll have doubled our money, (100% 10-day ROI) every hundred days, we’ll have ten-times as much money (1,000% 100-day ROI) and in one year we’ll have earned $3,650, which is 36.5 times our initial investment (3,650% APY)!
The Plot Thickens
Now the next day, something unexpected happens. Ten more people show up and they each give Larry $100. Larry now has a total of $2,000. When Larry goes to dole out the days fixed supply of 100 pickles, each person now only gets 5 pickles!
“I know it’s not as many as you expected” Larry says, “But with all 20 of you each loaning me $100, and only 100 pickles to give out, you each now only get 5% of my daily pickles”
“Don’t you know, Larry” they protest, “This means that in a year, we’ll receive half as much money as we thought we would! Now we’ll only make $1,825 this year (1,825% APY)!
The next day, having collected their 5 pickles each from Larry they arrive at the market to find that the pickle price has climbed to $2 per pickle!
“Huzzah!” they exclaim. “We are once again making $10 per day and we are once again on track to make $3,650 in a year (3,650% APY)! There’s no way this will change, we’re all gonna be rich!”
An Unwelcome Visitor
The next day, all twenty of Larry’s friends are waiting outside of his house.
Larry isn’t usually this late.
A few minutes later, he emerges from the house with someone new, who
Larry sheepishly introduces as “Whaley”.
“Hey guys” Larry stutters “Whaley here has decided that he wants to join the pickle program — But don’t worry, I’ll honor my original deal and split the 100 pickles between you evenly based on the money you contributed”
When Larry doles out the day’s pickles, each of the original friends are shocked to find a single pickle in their hands.
“What the heck!” the original twenty friends cry, thinking there must be some mistake.
“Well you see” Larry says, “Whaley here contributed $8,000 dollars. And while I appreciate the $100 that you each contributed, he now is fairly entitled to 80% of my 100 pickles. You each now get only 1 pickle each per day”.
When the friends go sell their single, lonely pickle, they find that alas, the price has once again dropped to $1 each. They figure that if things stay like this all year, they’ll get $365 each year based on their initial $100 investment, in other words, a measly 365% APY.
