How much do you know about the risks of DeFi income farming?
Editor's Note: This article comes fromGolden Finance, reprinted by Odaily with authorization.
Editor's Note: This article comes from
Golden Finance
Golden Finance
, reprinted by Odaily with authorization.
Today, DeFi income farming is still very popular, so as a "cryptocurrency farmer", do you know how much risk you are taking? Let us discuss it in detail today.
Banks are the most typical example of a "centralized intermediary", but after the emergence of DeFi, users do not need to rely on centralized financial service providers such as banks. Many DeFi projects allow people to borrow money directly from other people, which is very convenient. After these people lend money, they can exchange it for rewards built into the DeFi network.
Given that many decentralized finance projects focus on providing lending or asset exchange services, these projects need lenders and market makers who provide liquidity. To reward those who lend assets, projects typically mint a native token and distribute these tokens to all lenders, usually in proportion to the percentage of the total loan pool represented by liquidity provider (LP) funding. The percentage of these tokens held also represents the percentage of project ownership. If the utility of the project is getting better and better, the corresponding native token or governance token will increase in value, and in some cases, these tokens can even be used to pay some fees stipulated by the platform. Not only that, but these tokens will enable token holders to vote on how the protocol is run and governed.
Currently, the vast majority of decentralized finance project tokens are trading at very high "non-zero nominal values" (non-zero nominal values), which is due to the market being very bullish on the disruption brought by decentralized financial projects , so even though the interest rate itself may not attract lenders, the availability of decentralized finance protocol native tokens or governance tokens, and the potential for exponential growth in the price of these tokens, will also induce people to participate in staking. The main purpose of staking is to accumulate decentralized financial platform governance tokens, which can then be value-added through yield farming.
If you compare the Annualized Yield (APY) metric, the ROI of cryptoassets dwarfs the “free market yield” of centralized traditional finance. All of this sounds amazing, but it should be noted that staking on decentralized financial protocols also has great risks. It is crucial to understand these DeFi protocol risks, because these risks are largely related to the code security of the decentralized financial platform, and there are several risk situations that may make you lose some or all of your pledged funds.
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Be wary of yield farming risks
I believe that not many people have carefully read the codes of those decentralized financial protocols, even if they are all open source, of course, there are only a handful of people who have the knowledge to discover malicious codes or bad codes, because many people do not understand the program codes. Even if you want to conduct a large number of code reviews, you must take into account that this work often consumes a lot of time, and the growth rate of DeFi locked positions and token prices is amazingly fast. Perhaps when the audit is completed, the entry has been missed best time.
It can be said that time is very important for decentralized financial projects. This is mainly because the total amount of tokens distributed by decentralized financial projects is usually fixed. As the number of lenders and the amount of locked positions continue to increase, each lender receives The number of tokens will continue to decrease, resulting in a decrease in annualized rate of return. Therefore, it is common and very profitable for early adopters of decentralized finance protocols to participate in contracts without any technical due diligence. Generally speaking, the most technically savvy farmers are the ones who are most likely to reap high returns.
preventive solution
It should be noted that, under normal circumstances, the following four common methods will lead to the loss of principal. The first is economic manipulation: the code written casually in the agreement can be manipulated by humans. This situation may be intentional or unintentional, which will eventually cause the economic activities of the agreement to fail to meet expectations, thereby consuming the assets in the contract; the second is backdoor hacking : The protocol developer wrote the backdoor program and let the protocol contract exhaust all pledged assets. This method is usually called "exit scam". Basically, the assets pledged by users are difficult to recover; there is also a lock contract : The protocol developer codes the contract "in a certain way" so that a series of specific operations can lock the contract and prevent users from accessing all assets inside the protocol. Many well-known DeFi projects have tried this method; in addition, There is another risk that has to be paid attention to. Since income is based on governance tokens, the price of tokens at the time of final sale determines your return on investment. If the platform encounters unexpected negative events, the price of tokens will decrease. It will fall sharply, causing you to "lose everything".
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preventive solution
So, are there any strategies to deal with the above risks of income farming and provide protection for income returns? First of all, if you want to be a "good farmer", you should try to farm multiple crops, and the same should be true when yield farming decentralized finance projects. Dividing funds into many different projects can reduce the potential risk of each project. Of course, the premise of implementing this strategy is that you want to quickly enter hot new projects, but you do not have the ability to identify which projects may experience negative events. Only by cultivating multiple decentralized financial tokens and continuously liquidating tokens can profits be realized. The advantages of doing so lie in transaction speed, token breadth, and high risk tolerance.
Secondly, there is another thing to pay attention to, that is, if the token price of the decentralized financial project you choose to farm is very high, and you cannot quickly attract enough locked positions in the short term, then it is recommended that you find another better Good yield tillage farm. Generally speaking, decentralized financial projects with large and growing lockups have a longer survival time and are less likely to be affected by negative events. In other words, even if a negative event occurs, the chances of seriously affecting decentralized financial projects are lower.
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Yield farming or secondary markets, which would you choose?
In fact, when you carry out income farming, the capital itself will not increase in value. It is the DeFi tokens for income farming that really change in value. From this perspective, if you can directly buy tokens, then income farming does not seem to be the best Excellent choice. As the lockup increases, the token price increases, but it also means that the potential risk of loss also increases, so if you hold tokens and are doing yield farming, the best choice is not to sell tokens.
Summarize
In order to give liquidity providers more incentives, many decentralized finance projects will distribute tokens to those who pledge tokens in the liquidity pool of the decentralized exchange. However, if there is no liquidity in the secondary market and it is not conducive to decentralized financial projects, the rapidly rising token price can attract more people to pay attention to decentralized financial projects, which will allow the project to obtain more locked positions. Typically, liquidity pools consist of two types of assets. For any farmer participating in the liquidity pool, what they calculate is the impermanent loss (Jinjing Finance Note: The impermanent loss is the covariance between the two assets). If the sale price of the token is high enough to cover the impermanent loss, then it is a good deal for liquidity pool stakers. Because impermanent loss is a well-known risk, decentralized finance projects often offer very high token rewards to liquidity providers.
Therefore, when the market goes down, or once a negative event occurs, all locked positions will be cleared, and traders will lose less than farmers; and when the market goes up, especially when the market has an extreme rise In the case of , traders far outperformed farmers. Therefore, traders are in an advantageous position over farmers.
