Crypto for Advisors: DeFi Yields, the Revival

– S.M.

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2024’s Revival of DeFi Yields: This Time It’s Organic

Previously in Decentralized Finance (DeFi), rewards for participation have primarily come in the form of innovative, worthless, and inflationary governance tokens. Consequently, there were brief spells of excessive activity on fresh platforms, generating profits for pioneers. The rest were left with these tokens that held little value.

I’ve noticed a significant surge in digital asset yields lately, with stablecoin and Ethereum yield rates reaching over 20%, which is much higher than the base rate in traditional finance. Some have expressed doubts about this new wave of yield farming. However, I believe that while inflationary pressures may influence current trends, the overall increase in yields is primarily driven by organic and more sustainable demand compared to previous cycles.

From January 2023 onwards, the yield from liquid staking emerged as the standard return for digital assets and the last source of natural yields, given that borrowing demand decreased significantly during the cryptocurrency market downturn. The returns generated through liquid staking surpassed the federal funds rate for a large part of 2022. However, due to rate hikes in the previous year, liquid staking became less appealing as an investment choice. Nonetheless, it remained a reliable option for digital asset holders who preferred keeping their capital within the blockchain ecosystem.

As a researcher observing the digital asset market in Q1, I noticed that conditions began to show signs of improvement. This positivity was reflected in the rising yields of various digital assets. By the end of April, investors or users in this space could earn impressive returns. For instance, Ethena offered an Annual Percentage Yield (APY) of over 31%, while Maker upped the savings rate for DAI to 15%. Lending protocols such as Aave and Compound also presented enticing opportunities for lenders, offering yields between 6% and 10%.

As a seasoned crypto investor, I can’t deny the allure of these potential investment opportunities. However, I can’t help but recall past market cycles and ponder where these impressive yields are originating from.

In general, the returns on stablecoins and Ethereum primarily come from interest paid by borrowers with overcollateralized loans to lenders. Stablecoins are highly sought-after and liquid assets in the digital economy, and individuals often borrow them to amplify their investments in preferred assets.

As an analyst, I would explain it this way: For digital asset users with a keen interest in lending directly to EigenLayer and Ethena points farmers, consider employing protocols such as Gearbox. Due to the intense excitement surrounding points farming, borrowers are typically less concerned about costs and prepared to pay substantial fees – upwards of 30-45% – in order to fund their leveraged points farming activities.

As a crypto investor, I’d put it this way: Regardless of which platform or cryptocurrency lending protocol I choose, every loan is secured with collateral that exceeds the value of the borrowed funds. This safety measure protects me as a lender from potential losses. However, it’s essential to acknowledge that the demand for borrowing could decrease on any given platform at any time. If this happens, yields for lenders may decrease accordingly.

In the coming months, experts predict that there will be a surge in demand for borrowing among investors looking to speculate in markets. Despite the high costs involved, those participating in activities like leveraged points farming and other speculative investments remain unfazed. This creates a profitable opportunity for lenders. Although some digital asset users are wary of unsustainable yields, the current lending infrastructure effectively manages risks. For those uneasy about engaging with new investment primitives directly, lending provides an attractive alternative to capitalize on borrowers’ enthusiasm.

– Crews Enochs, Ecosystem Growth Lead, Index Coop

Ask an Expert

Q. How might new government regulations affect DeFi investing?

As a crypto investor in the Decentralized Finance (DeFi) space, I’m aware that as these platforms continue to grow, regulatory oversight is likely to become more prevalent. This could result in the establishment of uniform regulatory frameworks, which may involve stricter Know Your Customer (KYC) and Anti-Money Laundering (AML) procedures. Although these safeguards aim to secure investments and eliminate unlawful activities, they might also restrict the anonymity and agility cherished by many DeFi users today. Consequently, investing in DeFi could become a more regulated and intricate process for the average investor.

Q. What changes with traditional banks’ get involved in DeFi?

Traditional financial institutions bringing their expertise to Decentralized Finance (DeFi) could introduce a beneficial fusion of innovation and stability within the ecosystem. Banks’ involvement offers advantages such as risk management knowledge and access to a larger customer base, potentially increasing capital inflows into DeFi. However, this collaboration might result in lower yields due to the more cautious approach typically taken by conventional banking institutions.

Q. Do DAO’s impact DeFi yields and security?

Decentralized Autonomous Organizations (DAOs) play a significant role in the governance structure of various DeFi (Decentralized Finance) projects. In contrast to conventional finance, DAOs ensure greater transparency and community engagement through their decentralized nature. By granting stakeholders the power to cast votes on crucial matters such as yield rates and security measures, these organizations foster alignment between users and developers. This alignment can ultimately lead to more resilient and user-oriented platforms.

– D.J. Windle, founder and portfolio manager, Windle Wealth

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