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Describe the differences between Staking and Yield Farming.
Staking and Yield farming are entirely two different finance mechanisms investors have tapped into to generate passive income. Investors over the years have tried to find means to generate some income or gains from the ever growing DeFi space. Before yield farming, there was staking and before staking, it was the traditional mining method investors made income from DeFi.
Yield Farming also known as liquidity mining is a technique of earning income where investors lend their crypto assets to a liquidity pool (DeFi platforms) for the purpose of earning interest over the period. Decentralized exchanges on DeFi platforms to facilitate trades run on the platform need readily liquid assets, so they rely on these investors preferably called liquidity providers. These liquidity providers or yield farmers for lending their assets and adding to the liquidity pool, are rewarded with the token lent or multiple tokens. The yield (APY) from this kind of investment is high as compared to the other mechanisms but it comes with its own risk.
Staking in simple language is a way of earning rewards for holding a cryptocurrency. Staking entails depositing cryptocurrency in a pool that will serve as nodes for block validation. The node responsible for block validation receives a reward when the block is validated. The coin staked in that protocol is always the reward. Staking is associated with networks that use the Proof of Stake consensus mechanism to validate nodes on the network. The higher the amount of crypto assets you have staked, the higher your rewards and chances of validating a block.
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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 one of the platforms that offers users the ability to engage in yield farming. This is the link to the official website.
This is what you are greeted with in the home page.
Exploring the features.
On the home page, one can see the assets value he has expressed in USD on the Dashboard.
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The Wallet tab gives an overview of the assets value a user have in store and which has not been put to use.
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At Vaults, users get to see pools they can invest in and with the aid of a personalized technology on the platform known as the Yearn tech that helps maximize yield for investors.
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At Labs, there is a display of new opportunities investors can take advantage of. But because they are new, they come with high risks.
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Iron bank offers users to borrow and use their assets as collateral. Users can also invest here when they do not find a suitable investment option in the vaults. They can lend here and make interests.
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Connecting a Wallet to Yearn Finance
I will take you through the steps to connect a wallet to Yearn Finance. Here, I will connect my Metamask wallet.
- On the homepage, hit Connect Wallet.
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- Click on MetaMask to connect to Yearn Finance.
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To have this done on a Computer, you will need to add MetaMask extension to your browser.
When you add the MetaMask extension and import your MetaMask wallet, after you select MetaMask, a notification should appear asking you if your want to connect your MetaMask wallet. Click on Next.
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Another notification pops up, Click connect.
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When you return to the homepage, you will see the wallet connected like as shown below.
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Transferring funds from your wallet (MetaMask) to Yearn Finance
Enter the preferred pool you want to invest in.
Enter the appropriate transaction details and click on approve. (For the purpose of example sake, I do no changes and go ahead and click on approve)
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- A MetaMask notification appears asking you to confirm. If you have sufficient funds to complete the transaction, you go ahead and approve the transaction.
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What is collateralization in Yield Farming? What is function?
Collateralization is a popular finance term used in almost every loan instrument. In our traditional financial space, collateralization can be described as an asset the borrower uses as security to back a loan or credit facility. You will by now understand that yield farming has similar attributes like the traditional loaning system, where there is a lender and a borrower.
In yield farming, the borrower is required to make available some assets of matching value or sometimes more to that required from the lender so that in case of inability to pay back the loan, the lender can freeze that asset and avoid loss. Collateralization is very important as it reduces the risk of loss on the side of the lender.
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.
I will be performing this part of the task with data from Defi Pulse.
At the time of preparing this work the TVL of the Defi ecosystem stood at $111.22 B as per data from Defi Pulse. See screenshot below.
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TVL of Yearn Finance Protocol stood at $4.62B as per dats from Defi Pulse. See screenshot below.
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For data on the Market cap/TVL ratio of the YFI token, I will present data from CoinmarketCap at the time of preparing this work. See screenshot below.
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Whether the YFI token is overvalued or undervalued, we all understand that a TVL ratio less than 1 means the token is undervalued. From the screenshot above, the TVL ratio is 0.1779 so we can conclude the YFI token 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.
I will use TradingView to measure the performance of BTC and YFI over the period (August 1 to the time of preparing this work).
BTC/USDT chart.
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From the chart above, Bitcoin has a positive yield of 43.88% over the period indicating profit for investors.
YFI/USDT chart.
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From the chart above, we see YFI make a negative yield of -6.0% over the period which indicates loss for investors.
With these percentages we can compute the Return of Investment on each asset.
ROI on Bitcoin investment.
Remember we invested $500 and the yield returns for the period was 43.88%.
ROI = 500 + (0.4388*500)
= 500 + 219.4
= $719.4
ROI on YFI token investment.
Here also we invested $500 and the yield returns for the period was -6%
ROI = 500 + (-0.06*500)
= 500 - 30
=$470
From the two investments, we realized investing in Bitcoin gave the investor some profits and the investment in the YFI token rather reduced the invested capital to $470 which is a loss to the investor.
In your personal opinion, what are the risks of Yield Farming? Give reasons for your answer.
Like earlier indicated, yield farming is a very profitable investment same way it bears some risky components but as long as you know this risks and understand them, you can make huge gains from this technique. I will highlight some risks investors are exposed to when they engage in yield farming.
Smart contract risks. DeFi relies on smart contracts and this in one form or the other poses risk to investors. A bug in the smart contract can lead to a huge loss of investment.
To make the most out of this form of investment, one needs to properly understand how the whole system works and integrate numerous strategies to make huge profits from this kind of investment. Without proper understanding of how this works, one is likely to gain nothing or lose their investments.
Lastly, there is a risk of being scammed. So you decide to invest your funds into a liquidity pool you did not really investigate. Once your asset is added to the pool, the developers or the owners of the pool decide what they will use it for eg. lending to other users. Developers especially when they are unknown can just leave the platform with all the liquidity they have pooled and investors lose everything.
Conclusion
In concluding, the key take away from this whole piece is that Yield farming, also liquidity mining is a technique of earning income where investors lend their crypto assets to a liquidity pool (DeFi platforms) for the purpose of earning interest over the period. Yield farming has often been confused with Staking but we identified that the key difference between the two is as the former is usually concerned with interests and profits, the later seeks to holding a cryptocurrency on a platform with the focus on building the network (block validation as in Proof of Stake consensus mechanism) with a little concern on interests. Again, yield farming is relatively riskier to Staking.
Thanks for reading and kudos to @imagen for this challenging yet exciting lesson.
Regards