If you follow DeFi, you’ve probably noticed that the concept of yield farming is everywhere lately. From some of the most original memes in the Ethereum ecosystem to traditional news outlets like Forbes, crop rotation to maximize yield across protocols has become one of the defining activities on DeFi in 2020.
So, what is Yield Farming?
Yield farming is the act of leveraging different DeFi protocols and products to earn a yield or a return on their assets, in some cases obtaining profits well over 100% APY through a combination of lending interest and token incentives.
The recent yield farming frenzy made total value Locked (TVL) on DeFi skyrocket to new all-time highs, zooming far past $2B. Yield farming has had a substantial impact on protocols like Compound, Balancer, Curve, MCDEX, and Uniswap V2 just to name a few as DeFi users aim to cash in on the trend. This frenzy has brought some important questions to light. Should short term speculative usage of the Ethereum network be considered an indicator of long term adoption? Is this frenzy only a momentary activity that will lose traction once yields go down? Ultimately, is this the beginning of a new growth cycle for Ethereum?
How Did The Yield Farming Frenzy begin?
The Yield Farming frenzy started when Compound began the live distribution of COMP, its governance token, on June 14th. Compound reached more than $600M total value locked, and overtook MakerDAO for the first time ever on DeFi Pulse’s leaderboard, making it the #1 protocol in DeFi by this measure in a matter of days. However, COMP appears to have only been the beginning with Balancer having launched their protocol rewards incentive program in May started their live distribution a few days after Compound. Balancer experienced similar exponential growth, adding more than $70M TVL.
Although the frenzy started with COMP, yield farming has been known and practiced in DeFi for some time now. Synthetix, for example, had introduced the concept of protocol token rewards in exchange for liquidity provision to the sETH/ETH pool on Uniswap V1 in July 2019.
Things really started taking off a few hours after COMP began being distributed and users started heavily investing in the USDT market on Compound, the one paying the highest amount of COMP rewards. COMP is distributed on a 50%-50% basis between suppliers and borrowers of a given market, and total rewards are allocated in a proportional way to each market’s yield returns. One of the many strategies that were applied was taking out USDT loans with DAI as collateral and investing them in the corresponding market on Compound. Next, BAT became the most profitable market for COMP farming.
Compound’s team proposed to update the system’s liquidity incentive one week after COMP distribution went live on June 27th. The proposal looked to discourage an inorganic demand for BAT and other assets since users were concentrating extreme liquidation risks into these markets. The new liquidity incentive proposal was executed on July 2nd. Currently, COMP is distributed proportionally across the markets that borrow more dollars, and not dollars of interest paid. Rewards continue to be distributed on a 50%-50% basis between suppliers and borrowers of a given market. You can read more about Compound’s proposal to update the system’s liquidity incentives here.
The liquidity incentive effectively discouraged farmers from leveraging markets such as BAT. And now, yield farmers have ballooned the Compound DAI markets to levels higher than the total DAI in existence. You can check out the current Compound markets here and COMP distribution here.
Balancer began its live distribution of BAL on June 23rd, which caused a spike of more than $50M in TVL in a few days. You likely recall our previous DeFi Pulse Drop with Balancer Labs announcing their liquidity incentive program, which allows users to earn BAL on top of pool swap fees. Seventy-five million BAL tokens (75% of fully diluted supply) will be distributed among liquidity providers on a 145K weekly basis.
Is this the beginning of a new growth cycle for DeFi?
The current Yield Farming frenzy has some resemblances with the ICO frenzy of 2017, in which billions of dollars were invested across many tokens, which ultimately proved to be worthless. One of the main differences with today’s Governance Tokens is that these are being issued by protocols that already have running products that provide value to the ecosystem, instead of being outright scams. Even though it’s probable that today’s high yields will face a market correction and be lowered at some point, the current frenzy might still continue for some time. And as we have learned in the past, adoption increases after each frenzy: more users and developers are driven to the ecosystem, and the allocated capital funds the development of new innovations that are later used by a broader ecosystem.
Are you interested in learning more about Yield Farming strategies? Subscribe to DeFi Pulse Farmer to learn fresh yield farming plays and insights on big governance decisions.