Spool DeFi Insights – Overcoming the Challenges of Stablecoin Yield Farming | by Spool | Kitchen sink

The above is a quote from Canadian poet and writer Brian Bett. While it was originally written about more traditional farming, it could just as easily have been said about the current models of yield farming in DeFi. Not because the people and institutions involved lack knowledge or understanding, but because the sheer complexity of the current process they must go through makes “hope” a key piece of the puzzle.

In this article, we not only discuss the challenges of investing in DeFi through yield farming, but also the steps Spool has taken and continues to take to move investors from a place of hope to a place of control.

Warren Buffett said those words and still does, often avoiding the risk posed by technology products he himself admits he doesn’t understand. However, the nature of DeFi as a new financial model and even the novelty and rapid changes in the underlying blockchain technology make it very difficult for most people to fully understand the ecosystem and even individual protocols.

Matching this complexity is the level of individual analysis required of anyone wishing to enter this space as an investor. Since the creation of the first DeFi protocol, the mantra “DYOR” (Do Your Own Research) has become a standard for people in the field looking to attract new investors. A safety net, so to speak, to prevent problems from arising if someone follows the advice given and runs into problems as a result.

Unfortunately, DYOR is becoming less and less viable as an option as DeFi markets mature, product offerings become more complex, and investors are expected to break down multiple layers of technology on which their particular DeFi protocol is built.

The first challenge for many investors, especially as DeFi’s visibility increases in traditional finance circles, is entry and exit. This means they hold fiat currency such as EUR, GBP or USD and need to exchange it for cryptocurrency which can then be invested.

While this can be challenging, the cryptocurrency ecosystem has now evolved to the point that there are a large number of effectively regulated and mainstream solutions in this space. These centralized exchanges have proven processes that allow new investors to buy the cryptocurrency they need and convert the cryptocurrency back to fiat currency at a later date.

Due to the highly regulated traditional FX markets, these ramps are one of the most well understood and easiest to exploit phases for would-be DeFi yield builders.

However, the next step for a yield farmer is much more complex and risky.

In principle, yield farming is a simple business activity. You take a risk by giving your cryptocurrency to a third party who makes a profit from it, and you get a percentage of that profit. It’s a balance between risk and reward.

In traditional finance, there are numerous existing risk models and rating systems available to you, both as an individual and as an institution, that can support you in your investment decisions. Currently, these standardized approaches are not widely used in the DeFi space.

As a result, investors must search among dozens of DeFi protocols for a starting point to understand the risks and rewards of each protocol before deciding where to invest. The question is who do they trust, and often protocols with the biggest marketing budget and not the best solution win.

Many investors turn to Twitter for the wisdom of the crowd. While this can produce real results, it is also easy to spoof as some protocols buy tens of thousands of users and bots to get real users to invest. Combined with celebrities and influencers receiving payments from protocols they don’t fully understand themselves, potential investors can’t take their word for it.

Assuming an investor has identified DeFi protocols that seem suitable, they then fall back into the “DYOR” trap and now, in order to make an informed decision, they must choose the yield farming model in which they wish to invest. fully understand.

Not many people ask a traditional finance company what database their systems use, or sift through their code base to see if they can spot bugs. Instead, because they are regulated and have established oversight, one can be confident that these things are being handled correctly. Should this not be the case, there are also rules and regulations to protect investors.

In DeFi, the novelty and rapid pace of development has meant that regulation enforcement is poorly understood and applied, and support should a DeFi protocol encounter problems is minimal. This means that a potential investor wishing to reap the benefits of yield farming needs to understand not only the individual and non-standard terms used in a protocol, but also the entire technology stack, from the base chain to the end product. When the cryptocurrency and DeFi space was heavily populated and used by people with extensive development backgrounds investing in smaller volumes, they were often willing to do so.

As the ecosystem evolves from early adopters to a more mainstream investment model, this approach creates more problems, especially for larger financial investors. Traditional financial investors are less inclined to invest in a single-yield farming protocol.

While they may have extensive experience in traditional financial markets, understanding investing in DeFi and understanding the risks is beyond their experience. That means they need to hire from a limited pool of people who have the skills to understand protocols in sufficient detail and give them sound advice on options. This often comes at a significant cost, and when the goal is to maximize the profit margin, adding extra expense is not ideal.

This is also offset by the fact that DeFi markets and yield farming results are not as static as traditional financial markets, requiring 24/7 monitoring for potential issues and requiring quick responses when issues arise.

This rapid pace of change in farming earnings outcomes poses another challenge for DeFi investors of all sizes.

In traditional financial markets, many investors keep their investments for the longer term, with 5-year investments often being considered at the shorter end of the scale. DeFi is young and changing fast. To continue getting the best yields, investors may need to move funds within one yield farm or even transfer them to another.

With cryptocurrencies, the fees associated with these transactions can quickly increase, resulting in a significant reduction in potential profit from yield farming. Some blockchains in particular can be congested and fees can increase quickly at times. While under normal circumstances an investor would wait for these periods to elapse before moving funds or completing any activity, this may not be practical. For example, when a third party attack on a protocol occurs or a problem is discovered, time can become a critical factor.

Of course, this assumes that an investor has the ability to constantly monitor and respond to events not only in the protocol they are investing in, but potentially in the wider ecosystem as well.

Recently, our CSO Philip Zimmerer spoke about the role of infrastructure in DeFi. This expansion of infrastructure within the ecosystem will enable the next wave of investments, especially traditional financial investments. Essentially, investors need two things to do yield farming.

First, you need to understand the risk you’re taking with a yield farming strategy, especially for those handling other people’s funds.

Second, they must maximize profits from yield farming by ensuring entries and exits are timely and fees are kept to a minimum.

To meet these needs, Spool has a number of built-in features that are pioneering in enabling investors to grow profitably. To enable proper risk management, Spool has developed a method for risk assessment of individual protocols and allows you to build a portfolio according to your risk appetite.

Additionally, Spool has a process for others to create their own risk matrix for investors to use when setting up a yield farming Smart Vault. As we see more traditional finance firms understanding and moving into DeFi, we expect a range of risk models from recognized specialists to become available. Once your Spool Smart Vault (your portfolio) is created and funds are added, the process is automatically managed to provide the best possible return within the criteria you set. At the same time, fees are covered by the protocol to ensure the greatest possible profit is made.

Yield farming is an important part of the DeFi ecosystem, but to grow investment in this space we need to ensure potential investors have the crucial information and tools they need. That’s why we created an infrastructure product that removes the need for hope from yield farming and replaces it with informed decisions and maximum results. In this way, yield farming is becoming more widely accepted and institutional investment in this area continues to increase.

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Spool is a permissionless DeFi platform that connects capital aggregators with DeFi yield generators. Funds are dynamically and efficiently allocated to ensure optimized returns for individual strategies managed by DAO-curated risk models.

Spool was founded as a DAO, with a selection of founding members representing a diverse cross-section of the blockchain community.

Stay tuned for updates as we spotlight more members of the Spool team in the coming weeks.

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