How To Get DeFi Yield, And Why Invest In It
Your bank pays you a quarter percent. But some cryptos will pay you 6% or even way more for locking in funds for the “true-believers” in any particular decentralized finance (DeFi) protocol. If you’re not afraid of watching your token’s value fall 20% or more, then DeFi yield is your next crypto investment.
Yield paying DeFi cryptos are one of the main reasons why cryptocurrency investors have been diversifying from Bitcoin to the alt-coin universe, led by Ethereum. But for the past year, at least, it’s also been about Algorand, which I own, because it pays 6% yield. It’s not as safe as the Global X Super Dividend (DIV) ETF, which I also own. But Algorand and other tokens are – for investors – another way to capture yield in a diversified, crypto way.
Many of these DeFi protocols (think of them as fintech startups, in layman’s terms) are for investors that have a deep knowledge of cryptocurrency, the platforms they are operating on, and can lose most of their investment without losing sleep.
In short, there are many ways DeFi projects pay their investors yield, not just through ‘yield farming’.
A Quick Overview and Three Picks
DeFi is financial services running on public blockchains, primarily Ethereum. DeFi tokens earn interest, allow you to borrow, lend, buy insurance, or simply trade as a speculative crypto investment.
“Yield farming” is a reward scheme that’s taken hold in the DeFi crypto world over the last year. If you want to compare it to traditional investing, it’s like yield on a bond, or a dividend. It is arguably one of the main reasons investors who are not using Algorand, buy Algorand, among others.
Like a traditional dividend paying stock or bond, yield on DeFi tokens fluctuates depending on how these projects and exchanges roll them out. Anyone with a Coinbase account can easily discover which coins pay yield. It’s how I found Algorand.
“The focus of investors should be on the fundamentals of the project, not just the yield it pays,” says Eric Nguyen, CEO of Spores Research, and a former senior investment analyst of Elliott Management, a hedge fund with over $35 billion in assets under management. “If it is decided to hold certain project’s tokens over the long run, then exploring yield-paying systems is an option. But, deciding on coin investment purely based on the yield offered will be problematic since there are also downsides to take into account. One main issue is that annual percentage yield might be high but the staking period available is low – for example you can reach 200% APY in 15 days, assuming it’s compounded daily. In actuality your coin balance will only increase maybe 4.6% in those 15 days,” he says.
Like traditional dividend payments, if the price per coin goes up, then the yield paid on your crypto gives you new coins and now you have more coins that are worth more money.
But DeFi yield, for traditional Wall Street investors, is a little more like C rated junk bonds. High risk, high reward, if you get the timing right and the underlying instrument is sound and serious about paying what it promises.
“DeFi is trying to imitate traditional financial service providers with a decentralized twist,” says Gil Shpirman, CEO of Don-Key.Finance. In April, Don-Key completed a private funding round to bootstrap it’s Defi social yield farming platform to the tune of $2.2 million captured from some of the new blockchain funds like Black Edge Capital in Chicago, Genesis Block Ventures in the Caymans, MoonWhale of Bangkok, and Dubai’s Morningstar Ventures, to name a few.
Just as a bank takes a deposit from a customer and pays him 1% interest and then loans that same amount out to another customer and charges 5% in interest, a decentralized protocol will do the same thing but with a “smart contract” in the middle to reduce cost and increase efficiency. Investors are paid in “rewards”, which is like yield and – depending on the project.
“Some good examples are MakerDao, Aave and Curve,” Shpirman says.
The Maker Protocol is one of the largest decentralized applications on the Ethereum blockchain, and was the first DeFi application to earn significant adoption. Their DAI coin is a stable coin that basically trades in line with the dollar and pays around 2% yield. It’s one of the biggest stable coins and yield paying coins out there with a market cap of more than $4 billion.
Aave, another DeFi protocol I have been looking at to buy, defines itself as a non-custodial liquidity protocol designed for earning interest on deposits and borrowing assets in crypto. If you owned DAI and you deposited it in the Aave application, you could earn 1.57% APY. Aave pay yield for collateral, but not for farming.
Curve Finance is not for beginners. Its main goal is to let users and other decentralized protocols exchange stable coins and capture some yield that way.
“You are providing your capital and getting a return on them, but this is not without risks as some of the smaller DeFi projects have suffered exploits in the past,” says Nguyen, meaning “hacks”.
“You should pick coins where you understand the fundamentals and believe in their long-term value because the yield might not be able to cover the decrease in their value,” Nguyen says.
As this market becomes more sophisticated, and an extension of traditional Wall Street, investors who ultimately want to allocate more of their portfolio to crypto are going to need to do one of three things:
1) Wing it with the main coins – Bitcoin and Ethereum, or Grayscale ETFs that hold them, should you not want to be bothered opening an account on an exchange (you should do it, anyway)
2) Risk it with the DeFi coins you read about from trusted investors and other sources or;
3) Go find a specialist cryptocurrency firm, open an account with them, and let them do the work.
Don’t Fear the Reaper
The recent volatility in crypto, with Bitcoin struggling to get back over $40,000 and losing around $375 billion in market cap over the last three weeks, is unlikely to kill interest in DeFi investing, says Antoni Trenchev, Co-Managing Partner at Nexo, a regulated financial institution for digital assets with $4 billion under assets based in London.
“There are so many legitimate (DeFi yield) projects out there, but I think the future belongs to those that are compliant, well-capitalized, and scalable businesses with functional products and highly professional teams,” says Trenchev, who thinks Nexo is one of them. They give their investor clients tax-efficient instant cryptocurrency credit lines, a high-yield on both crypto and fiat, send and pay capabilities, high-level crypto trading, custodial insurance and a crypto wallet called the Nexo Wallet.
Despite some saying that a new “crypto winter” is starting, DeFi protocols built on Ethereum, for instance, produced all-time high revenues in May, according to data compiled by The Block.
The total locked value of liquidity pools in yield farming DeFi projects stood at $7,977,544,158 as of this weekend.
More sophisticated trades use DeFi marketplaces like Venus to lend their coins like a bank, and receive interest, or “rewards” in the Venus coin, XVS. That coin price is up nearly 10-fold since January. Some of the higher yielding lending pools are for those lending in Polkadot (DOT). It pays around 10%.
Pancake Swap is another one for sophisticated traders. Some of the trades on Pancake Swap are like 10x leveraged bets in a traditional market. I’d avoid.
For this reason, I’m sticking with Algorand and watch my rewards pile up in my Algorand wallet.
“If there’s one takeaway from the recent episode of market volatility, it is the reinforcement of the view that in crypto, you have to take the long-term view because, on the one-, five-, ten-year scale, it tends to outperform just about any asset,” says Trenchev. Their NEXO coin is up over 1,100% in the last 12 months.
“The space has survived and thrived because of and in spite of price declines of 30% and more, and a few times per year,” he says. “Cryptocurrencies remain the only free market left nowadays and show that an asset — such as Bitcoin — cannot be the best performer and also not be volatile. Volatility is an essential feature of high asset performance.”