Yesterday's thread on Uniswap struck a nerve. So here's one on yield, yield farming and insane yields in DeFi:

Let's try to understand yield vs. return first. Lending somebody money for interest, you are expecting *yield*: the interest payment. And you eventually want your money back. Buying ETH with USD, you are expecting ETH to go up and give you a *return* on investment (ROI). Now...

... if you buy ETH and then lend it to somebody for interest, the *yield* can help you get a higher *ROI*, because in the end, you'll have a bit more ETH thanks to the interest payment.

Yield and ROI can go in opposite directions. If you look at the pools on http://zapper.fi , you'll find some with negative yield and positive ROI, or with positive yield and negative ROI.

Here we have the first gotcha of yield farming: you can make lots of yield, but still have a negative ROI if you don't consider the portfolio that you are invested in. E.g. if you sell all your ETH for USD to farm CRV yield, and then ETH goes up a lot, you made a bad investment.

For the purposes of DeFi, it's best to think of yield as a nice "on top" earning for coins you already want to hold. Normally, you should not start holding stuff you don't want purely for the yield.

Depending on where the yield comes from, there's also a supply/demand issue. E.g. if a lot of people want to hold ETH, and offer it to others on a lending platform like Compound, interest will be low due to the high supply. Often, yield is higher on stuff people don't want.

So, yield is a type of fixed income that can come from many sources. In DeFi, those can for example be lending (like Compound), providing insurance (like Nexus), providing liquidity (like Uniswap), inflation (securing a protocol like Cosmos or Polkadot).

Typical DeFi yields are higher than CeFi yields because there's more risk, less supply, more technical skills involved etc. A typical range is 7 to maybe 30% yearly for the above sources of yield. Now, where do the insane DeFi yields - 1000% or more yearly - come from?

Part of the answer are protocol (often governance) tokens. Lots of protocols started distributing tokens to their users based on actual usage. Since those tokens are highly sought after on the open market, they are contributing a lot to the yields that DeFi users can achieve.

The protocols have various motivations to distribute those tokens. They want to put governance in the hands of their users, but they also want to attract new users and their liquidity. Hence these token distributions are also called "liquidity incentives".

Here lies a hidden gotcha of yield farming: farming for protocol tokens, you are not getting direct yield on the original tokens you are holding, you become a speculator on the protocol token. If you don't sell those immediately, your future yield could be higher, or much lower.

Another reason for insane yields in DeFi is composability.

Imagine you deposit some ETH on Compound (you'll start farming COMP and earn interest). With the allowance you now have, you lend some USDC (you farm even more COMP and pay interest). Now...

... you go to Curve, and deposit your USD into the Y pool. You'll earn yield as a liquidity provider. Now... you take the liquidity provider token you got from Curve and deposit it into the yCRV contract, you'll start earning CRV. Now...

... you think "wow, that's a cool recipe to earn yield, let me fuse that into a token so that others don't have to go all this way to earn some yield". You create mYIELD, which also uses CHI to save on some gas. Now...

... you deposit mYIELD into a Balancer pool and start earning yield as a liquidity provider on Balancer, and you start farming BAL tokens while earning all that sweet underlying yield.

Hello? Are you still with me?

Some parts of this example are made up, but in a nutshell, by finding clever "recipes" to compound yield across various protocols - sometimes even implicitly leveraging up your holdings - you can start earning insane amounts of yield. Being early in a new idea helps too.

Is this fun? Hell yeah. Is it risky? Hell double yeah. By combining all these protocols, you are in fact compounding risk (pun partially intended). If only one of the components of your recipe breaks, you might not even be able to unroll and recoup your original investment.

Some have started providing readymade services for this kind of composability-based yield farming. Most notably @AndreCronjeTech on @iearnfinance, and @Weeb_Mcgee on the bleeding edge. Explore their good stuff, keeping the above in mind.

The sky-high gas fees on Ethereum have turned yield farming into a whale game. Smaller farmers see their profits eaten by gas costs. So why should you even bother?

If you take your eyes off insane yields (tm) for a moment, you might observe that you intend to hold a number of tokens for a prolonged period of time and that there are well audited protocols offering small but still tangible yield on those tokens. This...

... is where you should start looking. If you can make +20% yearly on a bag you intend to hold for 6 month anyway, and you can do so in relative safety, holding your bag without yield will put you at a disadvantage compared to the traders who earn yield on their holdings.

Did you know that you can bridge your BTC over to Ethereum and start earning yield on it? Maybe I'll get to that some other time.

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