Decentralized Finance surges with “yield farming”

DeFi is one of the fastest-growing sectors in the crypto asset ecosystem. DeFi refers to the interconnected crypto assets, smart contracts, protocols, and decentralized applications built on the Ethereum (ETH) platform blockchain.

While Bitcoin (BTC) enabled individuals to make financial transactions with other individuals without the need for a financial intermediary, the Ethereum blockchain added another layer of programmability through the use of smart contracts.

The DeFi vision is to create a decentralized financial system that offers the same financial products and services seen in traditional finance without the need for a central authority. One of the core tenants of DeFi is composability, a design feature meaning that the components of a system can be connected to each other. In this way, the different products and services in the DeFi ecosystem can be linked together to create new products.

Compound recently became the largest DeFi protocol, according to DeFi Pulse. The Compound protocol allows anyone to supply or borrow Ethereum tokens through a decentralized market. People wanting to earn interest on crypto can act as suppliers to these markets and people wanting to borrow pay interest on their loans. For those interested in crypto yield farming, the returns are usually better than they can expect through legacy banking services. See the feature DeFi Crypto Lenders – Who Offers the Highest Yield for Depositors for the latest interest rates.

Under the hood, Compound works using cTokens to keep track of the accounting. When you supply assets to the Compound protocol, your balance is represented as a cToken, which can be transferred, traded, or programmed by developers to create new experiences, similar to other Ethereum tokens.

Users of the DeFi lending protocol recently voted to begin distributing the protocol’s native governance token, COMP. Compound is now the largest application in DeFi in terms of value locked into the protocol, with over 40% of the DeFi market. The COMP token is already up ~300% and began trading on Coinbase Pro in late June.

While Compound had a busy June, a separate DeFi project was introduced around the same time, with Ren teaming up with Synthetix and Curve Finance to launch a new incentivized liquidity pool for tokenized BTC.

Ren is an open protocol that enables the permissionless, private transfer of value between blockchains. The launch in May of the RenVM allows users to swap BTC to an Ethereum-based renBTC. This gives BTC holders the ability to lend their BTC and earn other tokens in return.

Synthetix is a decentralized synthetic asset issuance protocol built on Ethereum. These synthetic assets are collateralized by the Synthetix Network Token (SNX) which enables the issuance of synthetic assets. This pooled collateral model enables users to perform conversions between Synths directly with the smart contract, avoiding the need for counterparties.

Curve is an exchange liquidity pool built on Ethereum designed for efficient stablecoin trading, providing a supplemental fee income for liquidity providers. Curve allows users and smart contracts like 1inch, Paraswap, Totle and Dex.ag to trade with an algorithm designed specifically for stablecoins, while also earning fees. Behind the scenes, the liquidity pool is also supplied to the Compound protocol or iearn.finance where it generates even more crypto income for liquidity providers.

In addition to the normal yield produced by Curve Pool’s trading fees, the new collaborative pool includes an attractive basket of tokens for liquidity providers.

Behind the scenes, Synthetix and Ren have created a Balancer pool for SNX and REN where liquidity rewards are distributed in the form of wrapped SNX and REN. As a calculated side effect, this Balancer pool will also earn BAL tokens, which will be redistributed to Curve BTC liquidity pool contributors. Finally, the Curve Liquidity Provider tokens, CRV, is earned through the main BTC pool and will also be redistributed to liquidity providers. However, BAL and CRV tokens are not yet available on the open market and will be distributed pro-rata once they are available.

Each week, liquidity providers will receive wrapped SNX and REN, BAL, and CRV tokens in proportion to their Curve BTC liquidity contributions. Further, Ren and Sythetix are contributing 10,000 SNX and 25,000 REN each week, for 10 weeks. To capture all of the incentives available, liquidity providers will need to contribute sBTC, renBTC, and/or WBTC to the BTC Curve liquidity pool.

“Welcome to Yield Farming,“ states the Ren introduction to the project. “This is an experimental yield hacking exercise, the team is not able to assess the overall yield or outcome from this pool.” Check How to earn interest & boost yield with bitcoin and crypto for more on yield farming and the risk profiles of the different investment strategies.

Ethereum co-founder Vitalik Buterin has recently urged caution over the heightened market enthusiasim for crypo yield farming. “I think we emphasize flashy DeFi things that give you fancy high-interest rates way too much, he says. "Interest rates significantly higher than what you can get in traditional finance are inherently either temporary arbitrage opportunities or come with unstated risks attached.” Buterin adds that, “we should be solidifying and improving a few important core building blocks: synthetic tokens for fiat and a few other major assets (aka stablecoins), oracles (for prediction markets etc), DEXes and privacy.”

Other commentators such as Ari Paul of BlockTower have raised similar concerns. “The DeFi hunt for yield is nearing an interesting inflection point,” Paul tweeted. “As Compound competitors start to offer similar incentives, investors know that in aggregate, it will be ‘too good to be true’ in that the high yields are ultimately coming from a future intrinsic value.”