DeFi and the Yield Farming Phenomenon

DeFi protocols exploded in all metrics during the last month, passing $3B in Complete Worth Locked (TVL), triggered by the launch of the Compound governance token ($COMP) and subsequent “yield farming.”

What’s Yield Farming?

Most crypto protocols are designed to be decentralized. For base-level networks (like Bitcoin and Ethereum), that is achieved by Proof of Work, the place anybody generally is a miner and earn some BTC or ETH in change for serving to safe the community. In so doing, management of the community is kind of democratic (one CPU one vote).

  • Distributing $COMP pro-rata to customers of the protocol is free yield. It’s an added bonus only for utilizing Compound.

What Occurred with Compound

Yield farming drove a flood of capital into Compound — in a single week in mid-June almost half a billion {dollars} was added to Compound, driving complete worth locked (TVL) from $100M to over $1.7 B on the peak. $COMP equally opened buying and selling round $80 and exploded to over $300.

  1. Borrow 70 DAI in opposition to your 100 USDC collateral (paying curiosity however incomes $COMP)
  2. Commerce 70 DAI for 70 USDC (bonus: on a DEX)
  3. Repeat Step 1

Yield Farming is Not With out Danger

In environment friendly markets, elevated yield is reflective of elevated threat. Whereas DeFi is a largely inefficient market at present, outsized DeFi yields are nonetheless indicative of extra threat:

  • System design threat: Many protocols are nascent and the incentives will be gamed. (E.g., Balancer, the place FTX was capable of seize >50% of the yield attributable to a simple flaw)
  • Liquidation threat: Collateral is topic to volatility, and debt positions are susceptible to changing into undercollateralized in market swings. Liquidation mechanisms will not be environment friendly, and might be subject to further loss.
  • Bubble threat: The value dynamics of the underlying community tokens (like $COMP) are reflexive as a result of anticipated future worth follows utilization, and utilization is incentivized by anticipated future worth.

DEX Quantity explodes, begins to rival Centralized Trade volumes

DEX quantity rocketed upwards during the last month, and has begun to rival some centralized exchanges.

DeFi Stablecoins see sturdy Q2 development

Stablecoins used inside DeFi (notably Dai and USDC) noticed document Q2 development, as these are most popular yield-farming property owing to their low volatility which prevents liquidation threat. Each USDC and Dai market caps noticed >50% development, shifting from $700M to $1.1B, and $100M to $150M respectively for the reason that launch of $COMP.

The market cap of all ETH tokens recently surpassed the market cap of ETH itself. Whereas pushed largely by a number of property (LINK and CRO), that is nonetheless an intriguing flip displaying how the ETH ecosystem is increasing in worth quicker than the bottom native asset.

Ethereum Suffers Durations of Congestion; Highlighting Scaling Challenges

Predictably, DeFi exercise produced an increase in median gasoline costs, ranging between 40 and 70 Gwei at present. A single ETH switch prices ~$0.35, however extra complicated operations like swapping property on a DEX or coming into and exiting a number of yield-farming positions will be considerably dearer (at instances >$10 per transaction).

Different DeFi initiatives surge

  • Wrapped BTC Initiatives: Wrapped BTC initiatives create an Ethereum ERC-20 token that’s redeemable 1:1 for BTC on the Bitcoin blockchain, thus marrying the BTC and ETH chains and bringing BTC’s steadiness sheet into DeFi. These initiatives rose considerably as customers sought out extra capital for yield farming. BitGo’s wBTC and Ren’s rBTC are notable standouts, with ~$140M BTC locked between them (and wBTC the clear chief with $130M).
  • Balancer: A liquidity supplier and DEX much like Uniswap launches with a yield farming governance token, and rapidly grows to over $200M TVL.
  • Aave: A borrow / lend protocol much like Compound, however with added flash-loan capabilities, a local $LEND governance token, and differentiating mortgage merchandise. $LEND worth has elevated considerably following $COMP’s speedy rise, and Aave’s TVL has equally exploded to over $450M.
  • Synthetix: An artificial-asset protocol on Ethereum with related yield-farming mechanics, Synthetix has additionally seen unbelievable development. Their artificial greenback sUSD has captured quantity amidst the stablecoin explosion.
  • yEarn Finance: A collection of DeFi merchandise, together with a robo advisor that allocates your deposits to the highest-yielding protocols. They launched a governance token over the weekend ($YFI) with distinctive properties in that it has no earlier house owners and no exterior funding, a hard and fast provide, and is earned by yield farming. Upon launch, capital rushed towards farming and yields went as excessive as 1,000% APR.
  • Infrastructure: Chainlink, aiming to turn into the oracle bridge powering the suite of crypto and DeFi Dapps, surges to ATH above $8 and cracks top-10 by market cap; InstaDapp surges to just about $200M in TVL as a easy platform to simply handle yield farming positions.
  • Others: Ampleforth’s distinctive “uncorrelated token” surges; UMA releases a synthetic COMP token (yCOMP) to allow shorts, and a yield-dollar for fixed-interest loans; mStable holds token sale for his or her stablecoin protocol commonplace; bZx jumps on with uniswap providing of their governance token.

Implications: Is that this exercise real?

For all of the spectacular metrics, the rise in asset valuations, and meteoric development in worth locked, is it actually real exercise?

Are the valuations and returns sustainable?

Taking a step again, we are able to see a transparent cycle:

  1. Complete Worth Locked (TVL) will increase as customers farm governance tokens
  2. Governance token valuations improve on the again of skyrocketing TVL and metrics
  3. Yield farming incentives improve, repeating step 2



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