Jump Crypto: Five basic ways for DeFi players to earn stable and high returns

Summary

Original title: "Yield Farming for Serious People》

Original compilation: Biscuit, chain catcher

Summary

⦁ This article examines yield farming from the perspective of fundamentals, the operation of crypto assets to obtain compound returns. It clarifies the most basic value exchange in the whole mining process.
⦁ DeFi investors passively provide five forms of value: operating the network, providing loans, providing liquidity, managing agreements, and promoting agreements.
introduce

introduce

Warren Buffett once warned people to "never invest in a project that you don't understand." As a result, investors may see a world of yield farming: a world of wool (“airdrops”) and scams (“flush the rug”), ruled by self-proclaimed “old gamblers” and “stormtroopers,” Then they retreat immediately after making money.

However, after careful study, it was found thatYield farming is simply a business activity where DeFi investors provide value by taking risk.People are easily deceived by the mania of new protocols, false slang, and hot money flowing in the market. Yield farming is actually the reward for entrepreneurs who put in effort to build new platforms.

In this article, we explain yield farming through basic economic principles. In particular, we conduct research with two questions:
⦁ What core value did DeFi investors create? And get rewarded for it?
⦁ Who paid the bounty money, whether overtly or secretly?

For many traditional businesses, the answer is simple. For example, our local sandwich shop offers a range of services — sourcing quality ingredients, assembling sandwiches, and cleaning tables — for which diners pay directly. Yield farming is not complicated. Jargon aside,The strategy of most yield farming is to allow DeFi investors to participate in five types of economic activities in a passive and delegated manner:

⦁ Operating the network, e.g. validating transactions.
⦁ Provide loans to market users.
⦁ Provide liquidity to token holders.
⦁ Management and governance protocols.
⦁ Promote agreements, increase visibility, and enhance marketing effectiveness.

This article examines yield farming through these simple, abstract lenses to help current and potential investors understand their opportunity and assess their risk profile. As specific strategies are constantly changing, we will refrain from delving into the mechanics of any particular trade. Instead, we will explore the underlying fundamental concepts, which are broadly applicable to current and future yield farming.

What is Yield Farming?

The term "yield farming" is used repeatedly in many contexts. Our first step is to identify a specific and precise definition.Yield farming is a passive management strategy for earning a defined yield position in cryptocurrencies.[1]

• To manage passive policies:Participating in yield farming is hard work, and investors must constantly find strategies, manage risk, and adjust investment positions. However, we consider these strategies to be passive, as once a mining opportunity suitable for participation is found, the invested assets will be rewarded with little follow-up action required. This framework is in stark contrast to aggressive ways of getting paid, such as running a validating node or managing an algorithmic market-making strategy, that require ongoing technical maintenance.

• Clearly defined interest:To make our definition more precise, we focus on strategies with a clear interest payment schedule. Well-defined interest schedules come in many forms: fixed and floating, simple and complex. The timeline itself is what differentiates yield farming from simple buy-and-hold strategies (such as buying tokens or NFTs hoping to appreciate in value), as these do not have any clear interest schedule.

Yield farming can be further defined as a way of earning additional returns while holding the same position, relative to the traditional buy-and-hold strategy. To help better understand this definition, some examples from the traditional financial field can be compared.

• An investor who deposits cash in a bank account is not considered yield farming because it is routine and does not involve a management strategy. But investors who keep opening new high-yield savings accounts, earning bonuses and enjoying discounts will be income farming.

• Similarly, consumers who regularly use credit cards are not considered revenue farmers, but rather consumers who actively manage their credit card offer portfolio to maximize miles, bonuses and other rewards. In this case, the underlying asset would be a line of credit.

• Investors who only own stocks do not count as income farming, as this is the default buy-and-hold behavior with no clear gains. However, an investor earning interest by lending shares to short sellers would be yield farming.

• Investors who buy and hold and earn only fixed income are in an awkward position. If we consider cash as the underlying asset, then investors who lend cash to borrowers are indeed yield farming, as interest can be passively earned on the borrowing. But in many cases, we tend to think of fixed income securities such as bonds as the underlying asset, in which case the investor does not receive any additional return.

Of course, extra gains come with risks. In order to obtain these benefits, DeFi investors take risks and provide a series of value services for the agreement. We have counted five value services provided by investors.

1. Network operation

therefore,

therefore,The first major form of yield farming involves investors delegating tokens to high-quality validators, i.e. reliable and honest validators, in exchange for a share of the yield.If investors allocate tokens to low-quality validators, those validators may face negative consequences, i.e. collateral forfeiture, which will be borne by investors.

There are many examples, and it is easier for people to understand with two common examples. For example, traders on Coinbase can choose to stake their ETH on the platform, i.e. entrust their ETH to Coinbase as it participates in upgrading the Ethereum network to Ethereum 2.0, in exchange for approximately 5% annualized interest (based on rates at the time of writing). Alternatively, Terra traders can use the app to stake their Luna, i.e. delegate their Luna tokens to one of several different validators that handle the Terra network in exchange for rewards.

Now think about two questions: what economic value do investors create, and who pays them?

• DeFi investors allocate their assets to high-quality validators, allowing the network to operate more efficiently and securely.

• Rewards are paid by network participants who pay validators fees in exchange for a stake in using the network, and validators then send a portion of these fees back to investors.

2. Provide loans

The summer of 2020 is called "DeFi Summer", and the explosive growth of decentralized protocols has greatly changed the landscape of the crypto lending ecosystem. Before that, borrowing and lending mainly relied on large centralized institutions, but since 2020, a new generation of decentralized protocols has allowed individual traders to deeply participate in lending activities.

Thus, the second major form of yield farming is an extension of the first.Investors can lend cryptocurrency not just to validators, but to anyone. In particular, investors put tokens into pools, and borrowers borrow from these pools using collateral.

Many such protocols exist, the most popular of which are Aave, Compound, and Anchor. These protocols typically accept deposits in the underlying asset — an asset that already exists outside the protocol, such as UST in Anchor that can be lent to borrowers. These protocols track deposits by issuing new synthetic tokens to lenders (e.g., Anchor’s “aUST”), which lenders can use to redeem the original tokens and accrue interest.

Currently, almost all protocols focus on overcollateralized lending. As a result, lenders run the risk of their collateral depreciating faster than they can be liquidated. However, some protocols like TrueFi and Goldfinch are expanding into unsecured lending by vetting borrowers for some off-chain real-world information about them. Future DeFi investors may choose between lending agreements, accepting fully collateralized loans or directly bearing the default risk of borrowers.

As before, we ask the same two questions: what economic value do investors create, and who pays for their actions?

• DeFi investors lend tokens to traders in need, which allows these traders to express their views on asset prices more effectively. In the future, DeFi investors can also provide value by distributing tokens to higher quality borrowers and projects.

• Investors are rewarded with constant interest payments from borrowers (and a portion of the protocol itself). While some protocols temporarily guarantee a fixed rate, most give a variable rate based on supply and demand.

3. Liquidity

Liquidity provisioning, like lending, has been democratized and developed at scale through DeFi protocols. Previously, only centralized exchanges and professional market makers had the ability (fundraising, technical maintenance and continuous operation) to provide liquidity. Today, individual traders can do the same.

This is the third major form of yield farming.Investors deposit cryptocurrencies into liquidity pools (known as "automated market makers" or AMMs). Traders can leverage these liquidity pools to swap tokens—often paying explicit fees in addition to slippage.

Liquidity providers earn these fees and/or spreads by facilitating two-way liquidity, but also bear the risk of capital loss if the underlying exchange rate changes (market fluctuations). This is in stark contrast to active liquidity providers, who often adjust positions in response to exchange rate fluctuations.

Examples of major protocols running liquidity pools for DeFi investors include Curve, Uniswap, Sushiswap, and others. These liquidity pools serve as on-chain liquidity hubs, facilitating trades between many different asset pairs.

The same two questions, the first question - what value does the investor provide? The answer is straightforward.DeFi investors provide liquidity to those who need it, allowing them to trade tokens at prices with minimal market impact.

The second question is more complicated - who pays for this value? We need to note that liquidity providers are rewarded in three ways.

First, the AMM distributes direct rewards (i.e. transaction fees and spreads) to liquidity providers. Bonuses are paid by users who draw liquidity from the pool.

Second, issue rewards with their own native tokens, such as Curve issuing CRV tokens. (Note that Curve was the first protocol to successfully implement this model, which has since gained popularity and been widely imitated.) In addition to immediate economic value, these tokens often come with special reward programs (governance rights) .

For example, investors on Curve can increase their bonus in the pool by 2.5 times by locking their CRV tokens. Rewards consist of two parts. First, investors who hold a small amount of CRV receive lower fees from liquidity provision, implicitly subsidizing investors who hold a large amount of CRV. Second, non-investors holding CRV are diluted by the inflated CRV supply, again subsidizing investors.

Third, individual protocols may pay rewards to those who provide liquidity for their particular token.They do this by (directly or indirectly) purchasing governance tokens of large liquidity protocols, redirecting additional rewards into their token pools. This approach will be discussed in detail in the next section.

Some look like they provide liquidity to projects, but may be slightly different. For example, Olympus DAO is known for offering extremely high yields (currently 900%) for staking its OHM tokens. However, these gains are achieved through substantial token dilution, and they are largely rewards for marketing (we will discuss more in the final section). [2]

4. Management and Governance

While "code is law" is often cited as the blockchain motto, most crypto projects still have additional human intervention to channel funds, upgrade protocols, and address systemic threats. Most of these operations are done by means of decentralized voting — stakeholders initiate proposals and review code, vote on proposals, etc. But over the past few years, aggregator protocols have grown in popularity, especially for channeling capital.

The fourth major form of yield farming is to power aggregator systems that manage tokens in a passive and delegated manner.For example, the Convex protocol has been very successful in directing liquidity on the Curve platform to liquidity pools. The Yearn protocol has had similar success in China, distributing assets across multiple lending and liquidity protocols.

This reminds us that a single yield farming strategy may provide value in multiple ways. For example, DeFi investors can provide liquidity directly on Curve, or provide liquidity on Curve through Convex. He is rewarded for providing liquidity in both cases, but additionally rewarded for providing liquidity more efficiently in the latter case.

The answers to our two core questions—value provided and rewards earned—are more nuanced than the previous few. In particular, there are two ways for DeFi investors to earn income through governance protocols.

The first is value-creating, where productive investors create surpluses through more efficient management. Using the same example of Convex and Yearn, these protocols can reallocate liquidity to specific markets faster and cheaper than single-collateralized traders. (Note that aligning incentives with markets is a rapidly changing and evolving topic of debate.)

Second, investors are rewarded both explicitly and implicitly:

• First, investors get better returns by devoting resources to high-value protocols. They are then rewarded by users, such as borrowers or liquidity exploiters.

• Second, investors save on transaction costs by using such protocols. This can be very important - transfer fees on the Ethereum network can sometimes exceed $100 per transaction, which makes large transactions more attractive.

However,

However,Investors can also profit from management through value extraction:

• Investors can earn rewards via an aggregator or individually utilizing protocol-based rewards (such as Curve), but aggregators use the reward boost mechanism more effectively. Therefore, at the marginal cost, there is an additional incentive provided by small liquidity providers and token holders who do not provide liquidity continuously. In short, value is being transferred rather than created.

• In some cases, "could directly "bribe" investors to allocate tokens to specific mining pools.[3] These bribes often come from new protocols with the goal of channeling liquidity, incentivizing usage, and attracting attention. But The cost is higher for independent investors who see rewards diverted from their own mining pools, while non-agricultural token holders suffer from inflation.

As crypto world builders, we at Jump hope that governance and governance will continue to evolve, increasing the ratio of value creation to value optimization over time. For example, DeFi investors could be incentivized to support code upgrades, just as they are currently rewarded for choosing efficient smart pools. Defensive measures such as weighted voting may also help reduce bribery, trying to make the method feasible for large households to accumulate voting power.

5. Improve popularity

In the end, the key and practical criterion for yield farming players to measure the agreement is: big data is influence! In particular, the more TVL ("Total Value Locked", i.e. accumulated assets) a protocol has, the more attention it will gain, the more trust it will gain, and the more likely it will become a leader in the field. TVL may also affect the valuation of the protocol.

While the concept of “fair value” is still nascent in the crypto space, TVL multiples are commonly cited for assessing project valuations, similar to how companies use book value multiples and asset managers use AUM multiples. In these days of explosive growth for protocols, getting on the leaderboards can be one of the most effective ways to stand out.

Therefore, the ultimate value provided by DeFi investors is to increase the popularity and trust of the project through mortgage assets. To maintain this value in the ecosystem, protocols often reward investors for “earning” attention, which gives them time to grow and improve.

Specifically, the protocol requires investors to purchase and lock tokens in exchange for token distributions—the longer the lockup, the greater the reward. Of course, lock holders cannot make predictions about market fluctuations, and bear greater price risk than liquidity holders.

This mechanism is outlined in more detail in the article on token incentives. For users, token distribution helps to exert additional utility, which takes years to complete, by turning some of it into financial utility that can be realized immediately.

As a reward, locking limits supply (relieving sell pressure) and aligns incentives for DeFi investors with the goals of the protocol. That is to say: at the beginning you are doing it for the rewards, and at the end you are doing it for the utility - such a token distribution plan is successfully promoting the protocol through the development period.

Looking one last time at the central question of fundamental economic value and rewards, we arrive at the following conclusions:

• DeFi investors provide higher TVL for the protocol to increase rewards.

• DeFi investors are rewarded through the protocol, which usually provides rewards in the form of native tokens. This means that, in the short run, non-investors pay for these rewards by bearing the burden of inflation. However, in the long run, the protocol hopes to succeed in creating value and attracting new users. In this case, late-stage holders pay for early-stage (yield farming) marketing campaigns.

Conceptually, this channel is the most obscure and most prone to Ponzi schemes. In fact, protocols must address key questions such as whether they can retain users after the hidden marketing budget is over. But there are some successful precedents in the startup world, "blitzscaling" -- the strategy in which VC-backed startups heavily subsidize users to gain market share before raising prices.

This strategy has proven effective. The crypto industry is now replicating that playbook, generating massive payouts up front with the opportunity to realize massive value over time. Channeling the Lindy Effect, the protocol hopes to increase its market presence in the cryptocurrency space in the short term to ensure long-term success.

secondary title

Financialization and scale farming

Despite its many variations, the yield farming strategy at its core is fairly simple. Investors passively provide value to the protocol in exchange for direct and indirect rewards. However, with development comes a final factor: financialization. Crypto has developed a robust financial protocol ecosystem that allows DeFi investors to freely transfer assets and use leverage. This is how many DeFi investors increase the base single return to a more attractive level (such as 20% to 100%).

While the use of leverage in yield farming is beyond the scope of this article, we will mention a common example: liquidity staking. This is where investors deposit base tokens into the protocol and receive synthetic tokens. Investors can leverage their voucher tokens as long as the voucher is accepted as collateral by other lending protocols.

That is, an investor can deposit an underlying token (e.g. ETH), receive a synthetic token representing that claim (e.g. sETH), borrow ETH against that synthetic token as collateral, deposit that ETH, receive sETH, etc. This order is not unique, and the function of shorting or subdividing adds more complexity to the portfolio.

in conclusion

in conclusion

Essentially, DeFi investors are not that different from traditional investors. Both take risk (whether price risk or force majeure risk), deliver value, and reap the rewards. We hope that, as the fog of jargon and insider jargon clears, yield farming can evolve into an economic activity that helps the crypto ecosystem function more efficiently.

But, like traditional farming, yield farming is not an easy task. Although the concept is simple, yield farming in practice requires many abilities, such as discovering opportunities for value depressions, quickly adjusting positions, and understanding subtle risks in smart contracts. Sophisticated investors should be prepared to make mistakes and lose their assets at any time.

As the industry matures, we believe these issues will be alleviated and more individuals will be able to participate safely. Yield farming will then deliver on the better promise of cryptocurrencies — democratize finance and allow anyone, regardless of sophistication or wealth, to participate in the crypto world by providing these core sources of value.

Thanks to the research team at Jump CryptoJ, especially Sam HaribhaktiSam Haribhakti and Maher LatifMaher Latif for their feedback. This article does not constitute financial advice.

[1] Although "interest" in traditional finance more strictly refers to the value that borrowers pay to extend credit, we will continue to use it in the cryptocurrency definition here. ︎

[2] These benefits are achieved through frequent token rebases (3 times a day). Rebasing doesn't create value, it just redistributes it. For example, an APY of 900% would require a 10x increase in the token supply, which in turn would mean a 90% reduction in the value of each token. ︎

[3] It may sound unbelievable, but "bribes" in DeFi are standard terms for rewarding backers of a given proposal, not to imply improper or illegal inducements.