February 3, 2022 · 5 min read

Yield Farming: With Great Gains, Comes Great Hackability

The average interest rate of a savings account in the US is 0.06% APR. Crypto yields on the other hand have been known to offer APYs of over 100,000% (theoretically). With returns in that region, it’s not surprising that DeFi’s TVL ballooned from $8B in January 2019 to $80B today. The potential to earn generous passive incomes with crypto holdings has been driving enormous amounts of capital to the DeFi sector, as it continues to be one of its most appealing aspects.

Pioneered by Synthetix with the launch of its sETH/ETH liquidity pool in 2019, ‘yield farmers’ have never had more choice with regards to where they earn their passive incomes.

Yield Farming

Info gathered from DeFiLlama (updated 31 Jan 2022)

Convex Finance still leads the way for yield farming applications by TVL (total value locked), followed by Yearn Finance.

There are two main forms of yield farming and most yield aggregator dApps offer both. The first are known as ‘liquidity farms’. These involve liquidity providers or ‘LPs’ providing a pair of two different tokens, which are used by a smart contract to facilitate trade between the two assets on a decentralised exchange. In return for providing these tokens, rewards are earned in the form of trading fees charged by the decentralised exchange being provided for. 

The other is ‘staking farms’. These are pools automated by smart contracts which direct funds to crypto staking opportunities in order to earn staking rewards. This kind of farm is more accessible as only one kind of asset is required to deposit into the pool. Your contribution to the staking pool can sometimes also be staked in the platform itself in order to earn the platform’s governance token.    

A perfect example of the popularity and risks of this kind of yield aggregator dApp is Pickle Finance’s newest ‘pickle jar’ (staking farm) for LOOKS. Natively staking the LOOKS token of emerging NFT marketplace LooksRare currently yields around 400% - 600% APR. Around 40% of rewards are earned in LOOKS which are automatically reinvested into the stake (known as compounding). The WETH earned however (which constitutes the majority of the staking reward) is not compounded. The smart contract operating Pickle Finance’s ‘pickle jar’, reinvests the WETH portion of rewards as well. This results in astounding APYs of over 40,000%.    

This APY(annual percentage yield) is of course speculative and operates on the assumption that the LOOKS staking APR remains constant. APRs of over 400% are highly unlikely to be sustained for a year. However this ‘prospective’ APY has been appealing enough to secure over $4M locked in the contract already. Interestingly, Pickle Finance’s ‘pickle jars’ are simply forks of Yearn finance’s ‘vaults’.

Safety First!... Doesn’t Result In Great Returns

Pickle Finance was hacked in 2020, when a hacker managed to create a fake ‘pickle jar’ which would be recognised as legitimate by the dApp’s contracts. Almost $20M worth of DAI was stolen from the platform’s farming pool.

Depositing large amounts of money into these kinds of contracts is extremely risky. Regardless of how many times a platform purports to have been audited, they need to maintain impenetrable security at all times. All a hacker needs to do to become a multimillionaire, is get it right once. Even without the threat of a hacker, the developers of these applications are very often pseudonymous - meaning the risk of depositing tokens into malicious yield farming dApps is very real. 

That is the grey area in which there are (literally) rewards to be reaped. Participating in one of these farming pools (be it staking or LP), is effectively entrusting your funds to a block of code written to make the most lucrative investment decisions automatically. As a result, attractive returns can be expected. If a participant actually understands what is happening to their funds, they understand that they are placing a great deal of trust in the developers of the platform. 

The more people that enter farming pools, the lower the possible APY - meaning that being among the first to do so will result in the greatest yield (but also the greatest risk). Crypto.com encourages crypto holders to use their yield-pools with the slogan ‘Fortune Favours the Bold!’. While that might be true, it’s worth remembering that misfortune tends to favour the bold as well.

Written by Rob Henderson for Novum Insights

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