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What is Yield Farming all About? | CoinGecko Virtual Meetup #5

Shaun Paul Lee -
 
Yield farming in DeFi has been a hot topic in the cryptocurrency industry for the past few months. However, not many understand how it works. So, we decided to invite Michael Gu and Kerman Kohli to our Virtual Meetup #5 on Wednesday, August 26 @ 10PM EST to explain the intricacies of yield farming. 

Held monthly, CoinGecko’s Virtual Meetup is our live online community event where we explore different key topics in the crypto sphere and invite industry leaders to share their two satoshis. 

In our discussion, we touched on the current yield farming hype — the incentives, the risks and the prospects.

Here is a quick breakdown of what Michael and Kerman shared.

Michael gave a simple explanation of the mechanics of yield farming. It’s the process of depositing one form of cryptocurrency and receiving a different kind in return. 

“You walk into a bank and give them money to receive yield in return.” 

However, returns in yield farming are astronomical, with APY returns of over 10,000%. Michael initially thought that it had got to be a scam. He went on to explain that instead of doing an ICO, these projects are issuing their coins on yield farming, generating a lot of hype and encouraging people to buy. 

Kerman told us to imagine using Uber in its infancy 5 years back. But instead of paying Uber, you get paid with Uber stock for using their service. Since you’ve done a ride on Uber, the company is now worth a bit more. This then means that your Uber share is now worth more as well, and this becomes a loop to increase value. 

Both our guests believe that such high yields are not sustainable in the long-run. 

Kerman believes that in that the next three months, there will be more projects than a yield farmer can comprehend. There will be so many yield farming opportunities and will lead to increased competition, which will lead to lower and more sustainable yields. 

Meanwhile, Michael offered a more cynical viewpoint. 

He pointed out that yearn.finance (YFI) is a yield aggregator. It has Y Vault which allows you to farm other projects, which leads to a recursive loop. After YFI, there are other projects such as Shrimp (SHRIMP), Zombie (ZOMBIE), DFI.money (YFII), YFValue (YFV) and more. These projects are farming each other, which is simply a recursive loop. Also, projects are integrating other features into yield farming, such as rebasing and mining. Michael described this as the “honeymoon phase.” While interesting, he doesn’t think it’ll go on for a long time. 

“The way yield farming will look in the future is more of a coordination mechanism.” said Kerman. “If you think of YFI, and the rest, they seem like protocols but they’re actually games. In yield farming, it’s a way to get all these people who would take each other out if they could but instead force them to work together to create wealth for everyone.”

“I think a sustainable yield would probably be higher than 30%, though don’t hold me to that,” remarked Michael. 

These yields will also depend on the risks. This will vary according to the pool you’re farming in. If you deposit stablecoins into a contract, you won’t face the risk of impermanent loss. However, there is the risk of the contract breaking as well as getting your funds locked up. 

Meanwhile, if you put your funds into a liquidity pool, you run the risk of suffering impermanent losses. This happens if the token drops a lot in value, leading to impermanent loss, which becomes very permanent when you want to withdraw. 

For example, Michael purchased some YFFI, paired it up with DAI and did some liquidity farming with it. However, the price soon plummeted from $800 to $1. But since he was in the liquidity pool, he was essentially buying the dip as a liquidity provider since he’s buying every time someone sells. 

“For such pools, 300% to 400% could be sustainable for new projects since the risks are so high,” he said. “Since you’re providing liquidity for swaps, developers will want to incentivize you to do this. Market makers cost a lot, but these developers can provide incentives in the form of their own coins to liquidity providers to take on the role of market makers.”

Michael first started yield farming with just $100. While this may seem like a small amount, he was just testing it out before committing any more funds. He would test staking his funds, and then unstaking it, just to be sure it worked. 

Kerman has a contrarian opinion on that. 

If the project is good, you should just buy the token instead of farming it, especially if you don’t have $10,000 to spare. 

“Since these opportunities are so high risk, the chances of losing your money is basically the same as yield farming,” explained Kerman. “If your downside is the same, you might as well buy it and hope it goes up. That’s what I did with YFI, I didn’t think it would go on so long. But in retrospect, it was a good decision.”

“The way these things work, it’s almost like a game,” said Michael. “The coin is self-aware of its price and it can rebase to change its price.”

This rebase function affects everyone holding the coin. One example of a rebasing token is Ampleforth (AMPL) which needs to be at $1. In the situation that AMPL is at $3, it’ll increase its supply in order to bring the price down, and the price should gravitate towards $1. If it’s below $1, the supply will shrink to bring the price back to $1 and this is called rebasing. For YAM, the price went up, and the rebase functionality brought the price back down. However, because of a smart contract bug, YAM blew up. 

Michael and Kerman agree that there are multiple risks faced by yield farmers. For Kerman, the biggest risk faced is the integrity of the team behind the project. 

“If the team is anonymous, there is no reputation lost if it’s an exit scam,” explained Kerman. 

The ethics of the team is also another factor to take into account. 

“Have they created a backdoor which allows them to purposely break things, or to mint an unlimited amount of tokens?” he questioned.

“Maybe the code could be broken, and someone may one day just hit the right function and break it.”

As for Michael, he agrees that the risk of token minting is the biggest out there when it comes to yield farming. He also mentioned that rushing into any new project is risky as well. 

“What if the creator has the ability to mint an infinite amount of coins?” he mused. “This will allow them to mint the coins and just sell everything on the market.”   


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Shaun Paul Lee
Shaun Paul Lee
Shaun is a Research Analyst at CoinGecko, who has lived and breathed crypto since 2017. Previously a community manager for Synthetix and RedFOX, he dived down the crypto rabbit hole to grasp a better understanding of the industry. He now spends copious amounts of time on Crypto Twitter and Telegram, searching for the next idea for CoinGecko Research. Follow the author on Twitter @ShaunPaulLee

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