Yield Farming - Yearn Finance - Crypto Academy S5W3 - Homework Post for Prof. @imagen
Staking
Staking is a form of consensus algorithm at is used in validating blocks on the network. In Staking, funds are locked up in a liquidity pool, however, these funds make a network of nodes that works as validators in the network to ensure the security, continuity, and integrity of the network. When a block is validated, the reward gained from the validation is given to the node that was involved in the validation. After some time, the investor receives a reward which is of a certain proportion of the staked token.
The chance to validate a block increases as the amount of funds increases
This consensus algorithm is a result of some deficiencies in the Proof of Work mechanism. The PoW is very expensive due to the fact that it requires some high-level computer hardware and consumes a lot of electricity. These factors will determine the rewards received. Staking was then introduced, it was more energy-efficient and did not require that high-level hardware.
How staking works
Basically, staking is locking cryptocurrencies on staking platforms to earn rewards for the investor, user or staking pool whose assets have been locked.
the process
• The funds to be staked if meets the minimum requirement is deposited in the network as the stake.
• The chance that the node will be chosen to validate the next block is increased as the amount of the staked fund increases.
• When the node validates a block, the investor gains rewards
• Validators may be punished by taking a part of their staked funds if they are unable to perform their duties as validators in the network.
Risks involved in staking
• Rewards for the locked-up funds may delay
• There is a validator risk where the misbehavior of a validator may affect returns
• Funds may be stolen or loss
• The lock up time may be extended further
• There is also a risk of validator cost
Yield Farming
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To create a passive income flow for yourself in the crypto world, Yield farming is one way to go. It is a very innovative idea. Yield farming is basically investing your digital assets to accrue interest over time. Investors who go through this method are known as liquidity providers and they contribute their funds in a liquidity pool where it is locked and left there over a period of time to gain those interests.
Just like banks use the invested funds to give out loans to other customers, the funds invested in the liquidity pool are also used to give loans to other users and carry out trades that will also generate interest. The interest earned by the platform is then shared with the liquidity providers based on the proportion of the staked asset. The greater the asset that has been provided (locked) the greater the return. Unlike our real world where the currency you invest in is the currency you receive your interest in, in yield farming, you may receive other assets or the same asset as an interest to the investment.
Just like in banks and other institutions where the investment gains returns through an interest rate, yield farming also offers similar but here, it is called the Annual Percentage Yield (APY) and it compounds the interest on the investment at a fixed rate annually within the course of the investment period.
In some cases, the rate may not be fixed, such cases is when the platform is a Decentralized and makes use of the Automated Market Maker (AMM) mechanism. This mechanism calculates the yield based on the market’s supply and demand hence the yield will not be stable. Liquidity providers will then have to choose between platforms for the best current APY.
Usually, investors lock up their funds to participate in the development of a DeFi project which, might be grown in value in the future.
Risk in Yield Farming
• There is a smart contract risk, bugs may be present in smart contracts that may present criminals with loopholes to steal funds
• There is a risk of impermanent loss
• There is also a composability risk
Some platforms that give opportunity for yield farming are;
• Uniswap
• Compound finance
• Aave
Differences between staking and yield farming
| Measure | Yield Farming | Staking |
|---|---|---|
| Meaning | the act of locking funds in a blockchain to receive passive income | the process of locking in funds on a blockchain to be selected as a validator |
| Objectives | it aims to give high returns to investors in the blockchain world | its purpose is to maintain the security of the network |
| Mechanism | automated market maker | proof of stake mechanism |
| Rewards gained | users gain returns based on the APY | users get the chance to validate a block on the network |
| Return rate | higher APY | comparatively lower return rate |
In both yield farming and staking, the investor may face the risk of an impermanent loss. Impermanent loss is when there is a decrement in the market value of a token after it has been locked and makes the investor lose funds. Also, when there is an increment in the market value of the token, the investor makes great rewards.
The loss is not realized when the coin is locked, the loss is only shown when the coins are unlocked. This is why it is advisable to only involve in stable coins in the stead of altcoins which are more volatile.
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.
What is yearn.finance?
According to Defi Pulse. This is what Yearn Finance is.
yearn.finance is a decentralized ecosystem of aggregators that utilize lending services such as Aave, Compound, Dydx, and Fulcrum to optimize your token lending. When you deposit your tokens to yearn.finance, they are converted to yTokens, which are periodically rebalanced to choose the most profitable lending service(s). YFI, yearn.finance's governance token, is distributed only to users who provide liquidity with certain yTokens. With no pre-mine, pre-sale, or allocation to the team, YFI strives to be the most decentralized token. Although most of the ecosystem was built by Andre Cronje, control of YFI was transferred to a multi-signature wallet, which requires 6 out of 9 participants to agree on changes. Information source.
Yearn Finance is an Ethereum based platform that offers users the opportunity to engage in yield farming and also helps in lending assets to users.
To explore the Yearn Finance platform, we will have to visit the official website of Yearn finance https://yearn.finance/#/home
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To unleash the features of the platform, you first have to connect a wallet first. To connect a wallet, click on connect wallet on the top right corner of the page.
Select your preferred wallet from the ones present on the page. In my case, I will be choosing the MetaMask wallet.
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Log in to you MetaMask wallet and confirm the connection
Click on Next
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Click on switch network to change the network on the wallet to correspond with the platform.
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The wallet has been connected successfully and we can go on with operations on the network.
We have already seen what is on the home option on the main menu on. Another option is the wallet. This section shows your assets that are being stored and not in use.
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The Vault section shows pools where users can lock their assets to gain rewards. Based on their APYs, the pools are ranked.
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The Lab section shows the information on the newest opportunities available on the platform
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The Iron Bank section gives users the opportunity to borrow funds from the liquidity pool. They are also allowed to supply to the pool here. It does not only perform these features only, it can also be used to keep funds if the user does not find a good pool to lock it in.
The setting option allows users to customize the page to their liking in terms of language, themes, etc.
When we stare down at the bottom of the page, we will see a different menu that contains the Gov, Docs, Security, and Disclaimer
The Gov option allows users to bring their ideas for the improvement of the yearn platform. There are sub platforms where the user can have a general chat or talk about a certain project.
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The Docs sections gives some information from how to use the platform, new strategies on the platform, vaults, Yearn stack, partnership programs on the platform, find some references to smart contracts and some utilities that are part of the yearn architecture.
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The Using Yearn section gives a step-by-step introductory guide on how to use the Yearn platform.
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The security section gives information on the security of the platform. From the vulnerability discloser process, Audits, and security assumptions.
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There is other information available at the far bottom such as Developers, Github, ecosystem, and community you can see their features below them. Such as their social communities and others.
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we also have yVaults which serves as a vault to keep your cryptocurrencies
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to lock Funds on the platform you can go to the lab section.The tokens have been ranked according to their respective APYs. Choose your preferred one and deposit. In my case, I will choose the CRV token by selecting lock.
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Select approve to continue.
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Your wallet prompts you on the transaction for you to confirm and give access to the yearn platform to access your tokens.
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What is collateralization in Yield Farming? What is function?
In our real world, when we take a loan from the bank or any financial institution, access to some properties or assets of the loan taker is given to the financial institution as to serve as a guarantee for the repayment of the loan in the future. So, in case the loan taker defaults in paying the loan the financial institution takes full custody of the asset.
This idea above has been employed in the operation of loans on the yield farming platform. In yield farming it is the act where a loan taker is required to deposit some of his funds to serve as a guarantee or security in the part of the loan payment.
There is a certain proportion of the loan that is required to be deposited as collateral, this proportion is known as the collateralization ratio. This ratio is already set by the platform. For instance, there could be a collateralization ratio of 200% which means a collateral of $200 is required on a loan of $100 before it can be given.
As mentioned earlier the collateral is to guarantee the payment of the loan. However, there could be a depreciation in price of the token taken as loan, this will also cause the depreciation of the collateral already deposited and might depreciate below the collateral ratio. When this happens, the user is prompted to deposit more funds to close the gap in the collateral loss. When the user is unable to deposit more funds, some of the collateral of the loan taker is liquidated to make up for the loss.
To prevent this from happening in the foreseeable future, some platforms demand overcollateralization so that it used to make up for any loss that may arise. That is the reason why the collateral is always higher than the loan taken, it is just to prevent future 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.
For the sake of confused readers, TVL is the short version of Total Value Locked. To access this information on a DeFi ecosystem, we will have to visit https://defipulse.com/
When the homepage opens, the TVL of the DeFi ecosystem can be seen written boldly on it. at the time of this post, the TVL of the DeFi ecosystem was $107.31B. And it dominates about 18.11% of the market. The Defi pulse index currently stands at 316.48. this is an index that follows or tracks the activities and performance of coins in the DeFi world, to see how determined they are in their development.
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To see the TVL of Yearn finance, scroll down a bit and find the projects in the DeFi world. They have been ranked based on their figures of total value locked. Yearn finance is currently ranked 8th. Click on it to find more information about the platform.
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The TVL of Yearn finance is shown below in different currencies. It is $4.31B in USD, 1.4M in ETH, and 100.1K in BTC. If you look at your right, you will find a graph representing the TVL of yearn finance over time.
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The native token of the yearn finance platform is YFI, it is ranked 102nd and has a current price of $28,326.86. A market cap of $1,037,831,595, a fully diluted market cap of $1,038,632,643. The token has a maximum supply of 36,666 and a total supply of 36,666 of which 36,637.72 is circulating.
At the time I was writing this post, YFI had a 24h trading volume of $138,971,522. The market cap per TVL was 0.1771.
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Here is an all-time price history of YFI in USD.
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Here is a summary of the price statistics of the YFI token
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Is the YFI token Overvalued or Undervalued?
Undervaluation of a token is when the price of the token seems unfair when it is studied.
The undervalue or overvalue of a token can be determined from the market cap to TVL ratio. If the market cap to TVL ratio of the token is less than 1, the token is said to be undervalued. It is overvalued when it is equal or greater than 1.
From the token statistics made earlier, it can clearly be seen and confirmed that the market cap to TVL ratio is less than 1 with a value of 0.1771, therefore, the token is undervalued.
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From the historical price chart on coinmarket cap shown below, it can be seen that the YFI token has been able to reach very high levels of over $90.0K.source This shows how far high this token can reach. Also, the platform offers some very good features to users which are very good, they give users good rewards. They offer good APYs some of which even exceeds 70%, not all platforms offer this.
The platform has also portrayed itself as a safe place for trading. The users are able to partake in the governing process and are also in total control of their funds. This builds trust and ensures the development of the platform. Looking at these prospects, it can be seen that both the platform and the token have very good growth potential.
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.
I will be performing this task using the trading view platform. The returns of BTC/USD and YFI/USD from 1st august till 1 December.
I will be starting with the YFI/USD
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From the chart, we can see that there was a depreciation of -13.09 in the price between 1st august and 1 December.
This implies there will be a loss of $500 * 13.09 = $65.45
Loss = $500 – 65.45 = 434.55.
From the calculation, our initial $500 investment in YFI will have been reduced to about $434.55
The BTC appreciated from 1st august to 1st December at a percentage of about 45.12%
The profit will be $500 * 45.12 = $225.6
Profit = 500 + 225.6 = $725.6
From the calculation, an investment of $500 in BTC in 1st august will yield a return of $225.6 added to the initial investment to make $725.6
So when we invest the $1000 in both BTC and YFI in august 1st, we will have 725.6 + 434.55 = $1160.15 and that is a profit on our side.
From the analysis above, we can see that BTC performed better than YFI. A loss of about 13% is not that great, we can still hold the position and I am sure there is going to be some profit in the future.
In your personal opinion, what are the risks of Yield Farming? Give reasons for your answer.
Here are some risks that may be associated with Yield farming
• Some yield farming platforms may be Ponzi schemes. There is always a fake version of everything. There are developers who may create fake yield farming platforms with the intention of deceiving investors who will then lose their funds.
To prevent this there should be proper research done on a platform before investing in it
• There are a lot of yield farming platforms in the system right now. Technically, a large number of investors present on the platform tells it is very popular, which may help in trusting that both the returns and the investment itself are guaranteed.
• As stated earlier, a change in the price of the asset locked may change in the negative direction due to its high volatility and will cause the block ratio to reduce further than what was borrowed. If this happens, part of the deposited tokens will be liquidated to take care of the gap.
• I have already explained the impermanent loss risk at the beginning of the presentation, this is there is a decrement in the market value of a token after it has been locked and makes the investor lose funds. Also, when there is an increment in the market value of the token, the investor makes great rewards. The loss is not realized when the coin is locked, the loss is only shown when the coins are withdrawn.
• smart contracts operating on the platform may become faulty and cause loss of assets. Criminals may find loopholes in the faulty smart contracts and use that as an opportunity to steal funds
Conclusion
Yield farming is one of the many investment opportunities in the DeFi world and the crypto world at large. It enables investors to earn passive income on their assets to improve their lives.
Since yield farming was introduced, it has gained recognition from a lot and that has made sure of its growth. The accessibility of yield farming has been improved due to the good number of Dapps in the DeFi ecosystem that gives the opportunity to users to engage in yield farming.
I have explained the difference between staking and yield farming earlier to make readers bear in mind that they are not the same though they may be similar. It is the choice of the investor to choose between the two that fit their preferences.
In addition, I will say that users should research the TVL, market cap to TVL and APY before they choose to invest in a token. This information is vital in determining the credibility and knowing whether the token is overvalued or undervalued.
Thank you, prof @imagen