Yield Farming - Yearn Finance - Crypto Academy S5W3 - Homework Post for @imagen
(1.) Describe the differences between Staking and Yield Farming.
Staking
Staking in clear terms refers to the locking up of some crypto funds by the holder. This activity is done consciously to aid in the protocols security hence a compensation is attached to it.
Staking has two ways which it can pull through. It's either you stake some stipulated amount of tokens so that you could become a block validator or stake via liquidity pools participation. The most preferred way is via liquidity pools although various platforms may have slightly varying conditions.
What is yield farming?
Yield farming refers to the process that involves careful planning by an investor on what tokens to lend and where to lend them in turn to get rewarded for it. Holders of Cryptocoins can use various lending platforms like Aave or Compound and alternatively, they could lend this tokens on DeEXs like Pancakeswap or Uniswap.
The token farming process is quite basic. All you need donia to choose a suitable platform and then deposit your fund their and then your reward comes in form of the platforms token and APY.
Staking VS Yield farming
Staking and Yield farming are both better ways of passive income generation and both share some features as well. However, the major difference bin the both of them is that staking no matter the form is aimed at securing the Blockchain protocol when crypto holders stake their tokens while yeild farming entails that token holders deposit their tokens on a DeFi platform.
Below are some other differences between them.
| SN | Staking | Yield farming |
|---|---|---|
| 1 | Staking comes with a defined reward in form of an APY. It is about 5% but can also greater than this depending on token that is staked | Yield farming requires a good investment strategy. It is not as plane as staking maybe, but it's reward can get upto 100% APY. |
| 2 | Rewards which validators as price when theh create new blocks is shared to stakers as reward. | Yield farm reward is pool determined and since it is cryptocoin, then it can fluntuate. |
| 3 | Staking do follow strict policy that is linked to the tokens blockchain Consensus. If there is a successful attempt to trick the system, then the stakers stand a chance of loosing their funds. | Yield farming is dependent upon smart contracts and DeFi protocols which can only be hacked if poorly written. |
| 4 | Staking does not encounter impermanent loss | Yield farmers however may encounter an impermanent loss due to crypto volatility. |
| 5 | Depending on the Blockchain protocol, staking is usually done for a fixed period of time and a few has defined the minimum fund that can be staked. | There is no rule of users locking up their fund in some stipulated time. |
(2.) 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.
Connect wallet
The first function I complete is to connect my wallet to Yearn Finance. In this part, I have used Metamask wallet
)
Steps;
.1 I click on connect wallet and i choose Metamask.
.2 Next, I am required to login and authorize my wallet. I click on next.
.3 After that, I click on connect
My Metamask wallet is connected to Yearn Finance!!
Home
On the yearn finance homepage is a dashboard that is showing total net worth of a connected user.
Wallet
The wallet feature displays the amount of YFI tokens possessed by the user
Vaults
The vault feature is an technological instrument that is powered by yearn to help it's users to earn passive income. You just have to deposit your token to the availabile pools and then choose a desired strategy.
!
Labs
Labs feature is alike the vault feature but with a higher risk and higher reward.
Iron Bank
This feature helps users borrow or lend tokens. Let's say you wish to purchase a coin which you have analysed to have potential. You don't need to exit your position on the current token which you hold. All you have to do is to use the current token you have as collateral to borrow another token which you may use to purchase your desired token.
Settings
This feature is to help users to modify their user interface to their desired outlook.
(3.) What is collateralization in Yield Farming? What is function?
Collateralization
Usually in the traditional financial system, to get a loan will require a collateral. This collateral refers to an asset that could be used to match the value or close to the value of the loan you are taking. This collateral also apply to yield farming. The pool will request a collateral in form of a token that differs from the token you wish borrow. In yield farming, the collateral is usually up to 200% of the token you wish to borrow.
In the case that this collaterals value is suddenly plummets, the pool in an attempt to cut down the loss will sell the collateral in an open market. Sometimes, a marginal loss could still be accrued and lenders will bear the loss.
(4.) 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.
(4.1.) The YFI token, is it overvalued or undervalued? State the reasons.
• At the time of completing this homework post, the TVL of DeFi ecosystem is $278.32 billion.
• The TVL of Yearn Finance is $6.78 billion
TVL Ratio = The marketcap of YFI/TVL of YFI =
1,055,803,591 ÷ 6,780,000,000 = 0.16
4b. By virtue of the TVL ratio, the YFI token is undervalued. This is because it's it's TVL ratio is less than 1.
i.e 0.16 < 1
(5.) 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.
Return on investment (ROI) is calculated as
ROI = (Current investment value - Initial Investment Value) ÷ Initial Investment Value
Current Bitcoin value = $56,315
Initial Bitcoin Investment Value (BTC value at 1st August) = $41,460
Current TFI value = $28,817
Initial YFI investment value (YFI value at 1st August) = $33,125
Total investment worth = $1000
Hence,
BTC ROI = (56,315- 41,460) ÷ 41,460 = 0.358
YFI ROI = (28,817 - 33,125) ÷ 33,125 = -0.130
To find the ROI on both tokens, I will add their individual ROI together
BTC ROI + YFI ROI = 0.358 + (-0.130) = 0.228
Hence the ROI on investment in monetary value will be
Total ROI × (Total investment worth)
= 0.228 × $1000 = $228
(6.) In your personal opinion, what are the risks of Yield Farming? Give reasons for your answer.
Below are some risks associated with yield farming
Price fluctuations
It is well known that the crypto market is a volatile place. Although yield farming could bring great investment returns, there is also a chance that the investor could make huge loss at the stance of token value loss.
Protocol glitch
Yield farming operations are being facilitated by smart contracts. Smart contracts are written programs that follow certain conditions and then act on its own as long as certian conditions are met. These smart contracts are also written by humans and humans are are prone to make mistakes. If this smart contract is being poorly coded, then a hacker attack could become successful thereby leasing to filund loss.
Conclusion
Yield farming grants loan to crypto users on submission of a crypto collateral. APY on investment could be up to 200% but much as yield farming could look more promising than staking, it is important to always remember that the risk associated with it is very high and hence requires careful personal study of its working principle since each protocols terms of service differs slightly from another.
TVL is simply the value of the sum of locked assets possibly in pools or staking. It is also a handy tool in he determination of the undervalued or overvalued nature of an asset.
Regards to professor @imagen