Don’t bet the farm on crypto yield protocols, diversification is key
Traders going all in on yield farming need to be prepared to do some serious research and move quickly to grab the best yields.
As a strategy, yield farming is not dissimilar to foreign currency carry trading where traders aim to lend currencies offering the highest returns and borrow those with the lowest interest rate.
Yield farming often involves tokens such as USDT, DAI and USDC, but protocols based on the Ethereum blockchain are also very popular.
DAI to US dollar (DAI/USD)
Farmers will typically move their crypto from one liquidity pool or loan platform to another in search of the maximum annual percentage yield or APY, which will often require flirting with riskier pools.
According to investor CryptoCookie, yield farms that allow single stakes offer a better user experience than many decentralised finance (DeFi) staking platforms.
“There are several popular swaps that offer this,” she says. “However, I am really excited about automated yield farming and yield farming management tools such as Weave or Gravity Finance's Silos.”
What is your sentiment on ETH/USD?
Leveraged stablecoin yield farming
New platforms are emerging all the time. Earlier this month, Wonderland founder Daniele Sestagalli tweeted that he was about to herald ‘a new era of leveraged stablecoin yield farming’ offering up to 40 times leverage to allow lower available capital to be able to earn like a much bigger one.
The first offering (done in collaboration with Yearn Finance) will apparently generate upwards of 80% APY.
But in a recent article, Tranchess co-founder Danny Chong suggested that the risks of yield farming needed to be reduced to attract more interest from individual traders.
Chong said that platforms tend not to cater to different investing profiles, indicate risk levels, or provide guidelines on where investors should allocate their capital.
One of the risk factors is impermanent loss, which occurs when the price of one of the assets moves significantly compared to the other half of the pair.
Ethereum to US dollar (ETH/USD)
Another issue is changes to lending interest rates caused by supply and demand where a suddenly plentiful asset will see its lending value fall.
Platform failure is also an ever-present threat.
There are a number of features investors should look for when choosing a yield farm according to Grayson head of business development at Weave.
Need for a ‘balanced portfolio’
“These include the security of the smart contract and team reputation – it will be even better if it is a doxxed team,” he says.
“Not every farming strategy needs to be degen play. You need to balance your portfolio to survive in a bear market and ride with the bull market. There is always an emerging trend in crypto and you need bullets to fire when you catch one.”
Grayson says any trader unable to understand market sentiment, tokenomics and how the team is going to deliver it won’t be able to invest with confidence and double-down while there is fud (fear, uncertainty and doubt) in the market.
When searching for yield farms, first look for the level of risk, especially where APYs go into triple digits. In addition, decide which networks you are looking to deploy on – if you cannot afford Ethereum gas, choose a cheaper option like SOl or MATIC.
That is the view of Kiril Nikolov, head of business development at Nexo, who says the minimum requirement for success is a good understanding of at least one or two tier 1 protocols such as Anchor (Terra) or Curve (Ethereum Mainnet).
“From there, you will require a good strategy for selling rewards and diversifying, which you can do by deploying on more protocols,” he says.
Short-term strategies are possible
“There are also some short term strategies that yield great returns but are only available for a few days or weeks, and others that are best optimised by compounding rewards on an hourly basis.”
The good news for traders is that yield farms do not demand a minimum level of investment as new networks allow for cheap deployments at any scale, with the fiat on-ramp being the only challenge.
“You don’t have to own a full bitcoin, you can simply own 0.001 bitcoin,” says Grayson.
“However, you do need to know what you are investing in. If you do not know where to start or how to judge, find a guru or a community that you trust. Anyone making a crypto investment needs to understand how a wallet works, what is EVM (an Ethereum Virtual Machine), how to read transactions and other key factors.
Bitcoin to USDT (BTC/USDT)
As mentioned earlier, one of the most contentious issues in yield farming is the extent to which investors are given sufficient information on risk and adequate guidance as to where exactly they should allocate their capital.
Nikolov accepts that there is so much information out there that keeping up with it at all times is nigh on impossible.
“There is also a lack of guidance in relation to the technical risks where even professional teams might struggle,” he says. “The best yield farmers learn to operate in a world of incomplete information, making the most of what they have.”
Users can usually only take what the protocol had built for them, acknowledges Grayson.
“They need to know how the market behaves and what the protocol will deliver in order to invest with confidence,” he adds. “A good community with transparency can help newcomers to make the right decision.”
For example, Weave allows experienced traders to develop their own strategy and share it (and the philosophy behind it) with their followers. New users can then choose the appropriate strategy to follow based on risk appetite and historical return.
Another important consideration for yield farmers is whether success depends on trading frequently and actively monitoring their positions. Grayson believes this is the case since traders need to balance profit with impermanent loss.
“Some users might check several times a day simply to decide when to sell and when to compound,” he says.
A passive approach may yield better results
“If you are yield farming several protocols at the same time it becomes infeasible to manage everything manually. Therefore, we also try to be a hub from which users can manage different yield farming strategies.”
However, Nikolov suggests a less active approach can be equally if not more effective, noting that yield farming is a very broad term that covers everything from passive small scale deployment to an institutional-grade, full time operation with a five person team.
“Active monitoring is a good idea to stay ahead of potential risks, hacks, and breaches,” he concludes. “But it is not a must. In fact, all too often optimisations such as selling rewards underperform against no optimisation.”
Markets in this article