Why Yield Isn’t The Most Important Number
Lesson #1 in the Crypto Yield Farming series
William Purcell was my paternal grandfather. At university, he majored in mathematics, but despite his intelligence was something of a rake in life. When he passed, my father was charged with handling his estate.
We never really knew how William managed to make money in his later years. He didn’t really work and yet he owned a number of homes and kept his third wife–who was 40 years younger– relatively happy (she did, incidentally, claim most of the inheritance).
When my father opened up William’s brokerage account, he discovered the secret. William had opened a large margin account with that broker and paid a small borrowing fee. Then he used the expanded sums to invest in bonds, which paid a much nicer yield than the fee cost him.
In fancy terms, he was a yield arbitrageur. In crypto-lingo, he was a yield farmer.
This is a series of lessons focused on following William’s way.
They complement The Art of the Bubble, because, as we’ll see, they can provide an enormous boost to your portfolio during the crash phase. My paid subscribers, in addition to everything else they get, will receive updates on my yield farm positions.
But we’re not going to do exactly what my grandfather did. We have cryptocurrencies after all, and they provide a set of opportunities that previous generations never had. To give you a sense of what I mean, consider the following points.
Bonds of United States Treasuries–held for 20 years–yield about 3%. Corporate bonds yield about 5%. Junk bonds–for the riskiest of companies–might yield 11%.
In the cryptocurrency world that’s nothing. Look at what the SwissBorg platform will give you for various coins (p.a. = per annum, which is the fancy Latin way of saying annual percentage rate).
That’s nearly 15% for the US Dollar Coin, which is just a digital representation for the dollar. And we’re just getting started.
Here is what you can get on the Bancor platform.
Yes, that is a 97.85% APR reward for providing liquidity to the Bancor exchange. And we’re still not done.
Here’s what you can do on Alchemix with their mix of staking and swapping offerings.
Yes, that’s a 262.5% annualized percentage rate.
That’s just too good to be true, isn’t it? All of this, or most of it has to be, right?
There are risks. As far as I can tell the Alchemix option is at risk of impermanent loss (yes, that’s a thing and no it’s not the same as permanent loss), but that wouldn’t matter to you depending on your strategy.
The primary concern, however, is just figuring out what strategy you want to use given all the complexity of this space. Let’s start with some basic distinctions.
What Is Yield Farming?
Now, I’ve already used the term “yield farming,” and it’s a confused term.
The metaphorical idea is that in the cryptocurrency world, the yields you can get for locking up and staking coins are variable rate returns. As a result, you need to pay attention to their yields as a farmer pays attention to their crops.
When the yield drops too low, you need to move it to a new field–a new platform with higher yields–or plant a new crop–change the coin.
That part of the metaphor is fine. The problem, and this is why I write that the term “yield farming” is confused, is that you can yield farm in three ways:
- there is yield farm boosting – for trades,
- there is yield farm leveraging – for a business, and
- there is recursive yield farming – for the crazy.
I’m kidding about #3 … sort of. You really need to understand what you are doing before you try that.
All of these activities involve paying attention to your yields because they have variable rates. But their purpose is totally different. We’ll review them all, even recursive yield farming, in this series.
For now, let’s just get all the terms on the table. To start, we need to distinguish between two classes of cryptocurrencies.
Stable Coins v. All Other Cryptos
If you are reading this, then you might already know that not all cryptocurrencies are the same. For yield farming, you need to divide them into two kinds.
- Stable Coins: Examples include Tether (USDT), US Dollar Coin (USDC), Binance US Dollar (BUSD), Terra coin (UST), and DAI. They all use different mechanisms to keep the value of one coin pegged to the price of $1.
- All Other Cryptos: Bitcoin is the most widely recognized, but everything from Ethereum to Doge and Karen coin are in this group.
This distinction turns on the function these coins play in yield farming. That function derives from how volatile their price is. If Bitcoin someday is as stable as the dollar, then you can treat it as a stable coin for yield farming purposes.
As a caveat, stable coins are not completely stable.
GlassNode has a technical review of several stable coins, but without all those details, what you need to know is that stable coins don’t actually stay at just $1. The following is a chart for how the coins performed during the March 2020 crash and afterwards.
DAI is a multi-collateral coin, meaning that it uses more than one form of collateral to keep its price. As a result, it’s not terribly surprising that its price moved the most. The other coins are maintained differently, so their price moved less.
While 4% to 8% might not seem like a lot, remember that for what follows we’re going to be looking at lending practices based on those price movements. If these coins are used as collateral and lent at 4x, and they move this much, then an 8% jump becomes a 32% jump.
Still, stable coins are much safer than cryptocurrencies. Bitcoin dropped 30% in a day on March 18, 2021. A 4x collateral loan based on that would cause more than an immediate total loss.
That’s why lenders that use cryptocurrencies usually offer loans based on 25% to 50% of the collateral that you put up. They are over collateralized, unlike typical loans. This loan structure is true even for stable coins.
And that brings us to the topic of safety.
We’ll discuss several platforms where you can lock up and stake your coins for yield. If you are using a lending platform, like LEDN which gives a 12.5% rate for USDC, they all have a long legal section that looks like this. READ IT.
It will usually say things to the effect of this: they are under no obligation to recover bad loans on your behalf.
Now, they usually have an automated system to ensure that loans are insured and only given out at specified levels, etc.
Moreover, if they have a lot of bad loans, it will destroy their business. So, they have a rational incentive to protect you.
Still, just be aware that these are higher risk loans than US Treasuries. Stay away from:
- Any platform that does not have a clear statement of their terms of service,
- Any lending platform that has no system in place to back up their loans.
Some that pass this “sniff test” include:
But even after passing that “sniff test,” make sure you read through everything before just using those. I might have messed up something, your country (or state) might have different laws, and so on.
Now we’re ready for the first big counter-intuitive insight.
Yield Isn’t The Most Important Number
On our Discord server or on Quora, when people ask me about yield farming, they usually want to know which site can give them the highest yield for their coin. While well-intentioned, that line of questioning rests on a mistake.
To illustrate, consider the following problem. Suppose that you had $10,000 and were pondering the following two investment options:
- Option A: Buy $10,000 of Ether (ETH) and stake that on Nexo for 8%
- Option B: Buy $10,000 of USDC and stake that on LEDN for 12.5%
Which is the better investment: Option A or Option B?
The right answer is that you do not have enough information. To figure that out you need to know when you bought ETH and what happened to its price.
If you bought it on April 15th of 2020, then your price for ETH would have been $172 (see below).
That would give you a 1396% return if you were still holding even now (6/12/2021). So the 4.5% difference between A and B is meaningless in a bull run.
Similarly, consider if you had bought ETH on May 10th for $4168 (see below).
The 42% crash since then makes earning 8% or 12% in compensation practically meaningless.
The lesson here is simple: If you are yield farming with anything that isn’t a stable coin, the yield you are earning (generally) doesn’t matter. What matters is the direction of the coin’s price.
To state the same point in reverse: the yield you earn only matters when comparing stable coins to stable coins.
What about comparing regular cryptos to other cryptos?
Then the yield still doesn’t really matter. If the OKB token, for the OKEx exchange, makes 50x, but your ETH only makes 10x, whatever their yields are doesn’t matter.
Yields on regular cryptos are just a boost to whatever performance they already have. Generally, the only time they matter, then, is when you are looking at stable coins …
… unless you have a business founded on yield arbitrage or you are doing recursive yield farming … but those are special cases.
So, that’s lesson one in crypto yield farming.
What I hope you come away with are three points.
- The safety of your platform really matters.
- The APR offered matters when you compare stable coin to stable coin, but not stable coin to cryptocurrencies. The 12.5% on USDC isn’t comparable to Bitcoin’s or Ethereum’s 8%.
- When you are locking up cryptocurrencies (not stable coins) for lending, what matters the most is the direction of the coin itself.
I’ve also given you all key places to go to earn better than 12.5% on stable coins like USDC. You can go to Bancor, for example, and earn more than 30%. They also have the only system in place to mitigate the risk of impermanent loss.
And because I want each one of my lessons to teach you how double your earnings (or halve your losses), I’ve also pointed those of you who are intrepid enough to the Alchemix site.
Paid subscribers will get updates on what I’m doing in yield farming, in addition to my trades. They’ll also get first notice of the results of my experiments.
I’ll try the crazy stuff with my money so you don’t have to. So, I think it’s worth your while. And remember to find us on Discord if you haven’t yet.
General financial disclaimer: This post is provided for entertainment purposes only. I am not giving you financial advice and I am not a financial advisor. You should expect no financial returns one way or another based on my statements. These points hold equally for any statements that could be attributed to The Art of The Bubble or any related business entities. If you decide to buy or invest in anything, then your returns and potential losses are your own. No statements about taxation are taxable advice and you are encouraged to consult your own tax professional. You are also encouraged to do your own due diligence before investing in anything.