[Yield Farming]- Crypto Academy /S5W3-Homework Post for imagen.
Hope your are all doing well. We are in week 3 of season 5 of cryptoacademy and today I am writing homework task for professor @imagen , which is about Yield Farming. Let's begin .
Describe the differences between Staking and Yield Farming.
With the boom in decentralised finance, users are exploring the every possible way and best means of earning income from DeFi. Income may be earned actively in the form of trading or passively through yield farming and Staking.
Yield Farming
Yield farming is recent and innovative technique of earning passive income on DeFi platforms. Here a user supplies tokens to the liquidity pool of the platform and earns interest as passive income. The liquidity pool is used for lending funds, carrying out trades, issuing loans etc to the users and collects interest from them. The earned interest is distributesd to the liquidity providers proportionate to the share of supplied tokens. More the percentages of tokens supplied, more is the yield. On DeFi platforms, Automated Market Maker (AMM) mechanism is in place to facilitate yoeld farming via smart contracts. The beauty of AMM lies in its way of calculating yield. AMM based yield depends upon supply and demand and therefore yield keeps on changing from time to time and therefore LPs can choose the liquidity pool that offers higher APY or APR.
Staking
Staking has its roots in consnensua mechanisms. To begin with, Bitcoin operates on PoW mechanism which is expensive and energy inefficient. To combat problems due to PoW mechanism, newer consensus mechanisms like Proof of Stake came into being. In PoS, users need to stake certain amount of tokens to validate transactions and earn rewards. However, the concept of staking has later been set to expand its domain of operation by centralised and decentralised exchanges and setting up of nodes and validation of transaction function has been eliminated for vast strata of DeFi users. That part is being taken care of by exchange and users only need tk stake funds and earn rewards.
So we can say that, Staking involving locking of funds on a particular network and get incentivised for that. Staking powers the platform and entitles the stakers to the incentives based on different APY offered by different platforms. The yield is however lesser than that seen in yield farming..
Login to Yearn Finance. Explore the platform completely and indicate its functions. Describe the process for trading on the platform (wallet connection, funds transfer, available options) Show screenshots.
Yearn Finance is a DeFi platform that offers various features related to yield farming and lending related issues based on Ethereum Blockchain. To explore Yearn finance, we log in to Yearn Finance at https://yearn.finance/#/home and explore all the features individually.
Home ( Dashboard)
On the main interface of Yearn Finance , we have dashboard where we have Total Net Worth , Vault Earnings , Vaults est. yearly yield. We shall discuss these terms later.
Source
Vaults
Vaults is one of the wonderful feature of Yearn Finance. A user deposit his funds into the vault and the platform than automatically utilise the users funds in strategies with highest APY and maximise the profit. It is beneficial for the user in multiple ways. Firstly, a user does not need to to track the tokens and cryptos available on the platform . Moreover, it is not possible for a user to keep track of assets all the time . The vault feature of Yearn Finance being a smart contract triggered, automatically execute the finds as and when opportunity is spotted. Majority of the vaults are stable coin based like DAI, TUSD, USDC, USDT, and curve pools etc. As vault feature is doing work instead of user, it charges certain amount of fee from user.
A user has to pay 2% performance fee and 2% management fee to the platform. Performance fee is taken from earnings generated on Vaults but management fee is a fixed rate of total funds deposited over an year. I think management fee charged by exchange is much more because for large cap investors two percent account for a huge sum but it is noteworthy that 2% is only debited when the deposited sum after deduction of the fee is is not less than the initial sum deposited into the wallet.
Iron Bank
Yearn finance iron bank is a comprehensive feature that allow users to lend and burrow their funds at variable APY rates. In addition users can earn interest on ununsed funds as well. Here a user has to keep his assets as collateral and borrow funds. Once user repay his funds , collaterals are released. The borrower pays APY that is distributed to lenders.
Labs
Labs section of Yearn Finance is just like conventional labs. Here new and may be unconventional assets or stratigies are added on experimental basis before they are added to Vault or Iron Bank. It never means that unauthoeiaed or scam projects can get added but new projects are added and subjected to exploration by users. Yearn makes it clear that users should check the audit of the tokens and participate at rheir own risk.
Wallet
Wallet provides easy access to all the products of Yield Finance by simple click. Funds are chanelised to particular product most easily.
Settings
One of the most important feature of Yield Finance is "Slippage Tolerance". User can choose 1% , 2% , 3% as per tolerance potential of users. In addition, there is option to choose theme. We have option like, mono light, mono dark, cyberpunk, classicv2 and custom. In custom theme, we can personalise theme.
Connect Wallet to Yearn Finance.
Yearn Finance supports number of wallets like Metamask, Trezor, Lattice, Portice, opera, keystone etc. For this task, I'll be using Metamask wallet. I'll start from Metamask wallet.
Go to your Metamask wallet. Presuming that your are logged in.
Click on top left corner, a drop down menu will appear. Select Browser and click on it.
Next we get different options to choose from like decentralised finance, decentralised exchanges, get crypto etc.
Click on decentralised finance and look for " Yearn" from list.
Next you will land into the main interface of Yearn finance.
At top right corner, we get option "connect wallet ". Click on it.
Next select Metamask, an option will pop up seeking permission to connect wallet ro Yearn. Confirm it and you are done.
Next we get to see the wallet address at top right corner.
What is collateralization in Yield Farming? What is function?
To understand collateralisation better, a brief mention of mechanism of loans in traditional finance will help us to understand it better. When we take loans, we have to keep some asset as mortgage. Mortgaged asset acts as security deposit to compensate the loan in case borrower fails to pay back. Same holds true for collateralisation as well.
Collateralisation in yield farming refers to a system where a borrower has to deposit some funds as a means or security against the borrowed sum. The collateralisation ratio is set by a platform that lends you funds. Collateralisation ratio is the ratio of funds deposited to that of funds borrowed. Suppose, a collateralisation ratio of 200% means that a borrower has to deposit double the amount of funds borrowed. For example, an exchange with collateralisation ratio of 200% would borrow you $500 on depositing $1000 as collateral.
The function of collaterals is to act aa security against borrowed funds. In case the value of collaterals fall below the ratio set by exchange due to decreased value of borrowed funds, the exchange may carry out forced liquidation of collaterals to compensate for loss in case user fails to deposit additional funds. So to avoid forced liquidation, a user must deposit additional funds. The overcollateralisation of funds demanded by some exchanges is a safety mechansim to prevent liquidation.
At the time of writing your assignment, what is the TVL of the DeFi ecosystem? What is the TVL of the Yearn Finance protocol? What is the Market Cap / TVL ratio of the YFI token? Show screenshots.
To look for TVL (Total Value Locked) of DeFi ecosystem, we will have to visit DeFi Pulse (https://defipulse.com/) . At the time of writing this post, the TVL of DeFi ecosysrem was 110.08 B and that of yearn finance was 4.518B.
TVL of DeFi ecosystem
TVL of yearn finance
The price of yearn.finance (YFI) token at the time. Of writing is $ 29,971.47 , with a Market Cap of $ 1,098,086,292, a Total Locked Value (TVL) of $ 5,5 963 i53 168, and with 36,637.72 units in circulation. Ratio of Market cap /TVL is 0.1841.
Coinmaeketcap YFI status
The YFI token, is it overvalued or undervalued? State the reasonsrea.
Determination of under Or overvalued assets on the basis of Market cap and TVL was altogether a new concept for me. As mentioned , if the MarketCap/TVL ratio is found to be less than 1, it is considered undervalued. As shown above from coinmaeketcap, ratio of Market cap / TVL is less than 1. so YFI is undervalued.
If on August 1, 2021, you had made an investment of 1000 USD in the purchase of assets: 500 USD in Bitcoin and the remaining 500 USD in the YFI token, what would be the return on your investment in the actuality? Explain the reasons.
BTC return on investment
We will be doing calculations in simplest possible manner :
BTC price on August 21, 2021 was $39,974.90,
So with $500 on August 1st, 2021 , we would have got = 0.0125BTC
BTC price today = 57053.48
0.0125BTC = $684.64
Return on Investment = (($684.64 - $500)/500) X 100 = $184.64 = 36.92%
Return of Investment of YFI.
YFI closing price on 1st August 2021 was $31,779.15.
For $500 on August 1st, 2021 , we would have got= 0.015733 YFI
YFI price today = 30088.80
0.015733 YFI = $ 473.29
Return on Investment = (($473.29 - $500)/500) X 100 = - 26.70 = - 5.30%
Total Return of Investment.
BTC ROI + YFI ROI= $184.64 - $ 26.70 = $157.94 = 15.794%
In your personal opinion, what are the risks of Yield Farming? Give reasons for your answer.
Yield farming is a highly profitable way of earning passive income. But there are certain risk factors associated with yield farming too. The most common risk factors involved In yield farming are :
Security is the most leading concern of everyone. As DeFi platforms are smart contract based and smart contracts are codified to work as commanded. Therefore, these smart contracts have potential of being hacked by technical miscreants. Funds once lost are gone forever . Smart contracts are also subjected to risk of bugs of idiopathic origin. For example, a bug in operation of smart contract on Yarn Finance led to drop of price of Yam finance token from $167.66 to roughly $0.97. However, it is now not uncommon to see the platforms insuring funds but for that one has to spend huge amount of funds too.
Impermanent loss is one more risk factor linked to change in value of assets supplied. Significant devaluation of any asset, owing to volatility of crypto market may end up yield lesser than the value of supplied token.
Small cap investor must evaluate risk benefit ratio especially on Ethereum blockchain where gas fee keeps on increasing with the fame of yield farming. However , alternative platforms have now come up. Last year, gas fee of Ethereum rose to 236 Gwei which is huge increase.
Manipulation by heavy fund investors can ruin small stake investors as has been seen in case of SUSHI price when founder of Sushswap removed his liquidity. There was fall of 73% in price of Sushi and you can understand how badly the small stake holders may have been grilled.
- Risk due to scams arising out of platforms created for fraudulent purposes cannot be eliminated. However, proper research about developers can mitigate such risks.
Conclusion
With the growing popularity of decentralised finance (Defi) , new means to explore the use cases for maximization of profit have come forward in the form of staking and yield farming. These are means of passive income generation by locking assets on platforms. The locked assets are utilized for different purposes like loans etc by platforms and the incentives generated thereof are distributed among liquidity providers