Yearn Finance played a leading role in the decentralized finance (DeFi) boom in the summer of 2020. Leveraging the Ethereum blockchain, Yearn Finance deployed smart contracts to maximize returns on deposits and generate high interest rates.
This process is called yield farming and Yearn Finance was a pioneer of this business. Let's start with the origin of the protocol.
Origin and purpose of Yearn Finance
Yearn Finance owes its existence to Andre Cronje, a South African programmer who has created and contributed to more than 25 DeFi projects. Many in the community call him the “Godfather of DeFi”.
In early 2020, Cronje pioneered two DeFi projects – yEarn Finance and iEarn. The latter was the first decentralized application (dApp) to use smart contracts for yield aggregation. The concept was simple:
- Users deposit crypto funds into a smart contract vault.
- The smart contract algorithm automatically allocates these funds to other smart contracts (DeFi platforms) with the highest interest rates (yields).
- Interest is paid by borrowers who access these vaults, just as customers turn to banks to make loans.
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In traditional finance, this approach would involve moving money between accounts to earn interest. There are no banks in the DeFi world. Instead, smart contracts hosted on blockchain networks serve as a liquidity depository for lenders and a source of liquidity for borrowers.
On both sides of the equation, borrowers and lenders interact with smart contracts. After iEarn achieved success in yield aggregation, Cronje renamed it yEarn, as in Yield Earn, which eventually morphed into Yearn Finance (YFI) in July 2020.
At its TVL peak in December 2021, Yearn Finance held $6.91 billion worth of crypto funds, an incredible 103,034% growth since July 2020.
Yearn Finance: Dark blue represents the Total Value Locked (TVL), while light blue represents the YFI market cap. Source: DeFiLlama
Yearn Finance's popularity reflects its core mission. The platform aims to simplify the DeFi experience so that crypto investors don't have to search for returns across dozens of lending dApps.
Interestingly, Yearn Finance is one of the rare projects that was not funded by venture capital firms. Furthermore, Cronje has not even raised private or public funds through YFI token sales. To keep up with the spirit of decentralized finance, Cronje has decided not to reserve YFI tokens for itself.
Key Advantage of Yearn Finance
Without Yearn Finance, investors would have to manually move their liquidity to the protocol with the highest return. As a talented programmer, Andre Cronje automated this process and scaled it for public use in the form of Yearn Finance.
In addition to making DeFi accessible to the average online adventurer, Yearn Finance implemented a suite of custom tools that serve as a yield aggregator for the largest lending platforms: Aave, Curve, Balancer, and Compound.
Of course, liquidity providers (LPs) are not limited to just lending platforms to engage in yield farming. Decentralized exchanges (DEXs) like Uniswap require liquidity to exchange token pairs, which also generates interest rates for liquidity providers.
Thanks to these YF tools, investors can search for the best interest rates available. To fund further development of the protocol, Yearn Finance charges a 0.5% fee for withdrawals.
Inner workings of Yearn Finance
Yearn Finance is a collection of smart contracts that work together to simplify yield farming. Each one ensures revenue aggregation:
- APY: Marks annual percentage returns from lending protocols across the Ethereum dApps ecosystem
- Earn: is the highest interest rate available
- Safes: a bundle of trading strategies within staking pools
- Zap: Execute the vault's bundle of trading strategies
The end user sees these four YF pillars, arranged like an intuitive news page. Once the MetaMask wallet is connected to the Yearn Finance platform, the account portfolio will be displayed in the front-end center, showing holdings, earnings, and estimated annual yield (APY).
Just below the user's portfolio, Yearn Finance displays three options with the highest APY as a version of the “Trending” middle section. Below these high earners is a listing of all yield farming opportunities in dozens of vaults, filterable by the vault's total assets and APR.
A list of APYs for DeFi platforms. Source: Yearn Finance
Vault is the cornerstone of Yearn Finance’s model. Yearn Vault is a smart contract that collects liquidity from investors, albeit from other platforms. To enable this inter-dApp connectivity, yTokens represent liquidity pools (tokens themselves are smart contracts).
Remember: When someone deposits liquidity into a liquidity pool like ETH/USDC on Aave, the liquidity provider (LP) deposits those tokens as-is to earn yield. A Yearn Vault is also such a yield-generating stake pool, but yTokens convert deposited assets into yTokens.
In other words, they are packaged as yTokens so that other smart contracts on other platforms can be accessed from a single aggregating source – Yearn Finance. Likewise, when funds are withdrawn, they are returned as yTokens. A case in point is Curve Finance's 6.56% APY Curve StETH Vault, which represents the Curve liquidity pool that holds staked Ethereum (stETH).
Source: Yearn Finance
By depositing liquidity into a vault, the user receives yield benefits as if accessing the Curve Finance platform. That's because Yearn Vaults does this for the user by routing deposited funds to the other platform, in this case Curve Finance.
Additionally, Yearn Finance employs trading strategies to achieve maximum returns. Depending on the type of staking pool represented by yTokens, these returns can come from LP rewards, trading fees, or interest rates.
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Additionally, these strategies run as batch transactions rather than single sequential transactions, significantly reducing ETH gas fees. Each yToken clearly outlines what strategy the vault uses to maximize returns. A user (liquidity provider) could deploy them manually by simply reading the description, but they would not be able to be as cost effective.
More advanced users can access Labs. This section of Yearn Finance lists vaults that employ unconventional and experimental yield farming strategies.
YFI Tokenomics
The YFI token is an ERC-20 utility and governance token. YFI token holders can use their stacks to vote on new trading strategies for vaults or even change withdrawal fees and other aspects of the protocol.
YFI tokens are almost as rare as typical NFT collections. There is a maximum supply of 36,666 YFI tokens all in circulation. Due to its rarity and high demand, the YFI token price reached an incredible high of $93,435 in May 2021, while its all-time low was $739 in July 2020 when the platform was just gaining traction.
Not only can YFI tokens be earned by depositing funds into Yearn Vaults, they are also available on decentralized and centralized exchanges.
Risks associated with yield farming
Whether indirectly through Yearn Finance or directly, yield farming can be risky. According to the Chainalysis report from August, up to $2 billion worth of crypto assets were withdrawn through smart contract exploits.
Source: Chainalysis
In addition to the technical vulnerability resulting from poor coding practices and lack of auditing, the assets themselves could be risky. For example, algorithmic stablecoins are pegged to other cryptocurrencies, making them vulnerable to extreme market conditions.
TerraUSD (UST), DEI (DEI), Fantom USD (fUSD), and Neutrino (USDN) are just some of the algorithmic stablecoins that failed to maintain their dollar peg. If this happens in liquidity pools, secured loans could be liquidated.
Furthermore, due to interconnected trading strategies, one devaluation of the token could lead to another, triggering a contagion cascade. One only has to look at the Yearn Finance TVL chart above to see that this has already happened after Terra (LUNA) collapsed in May.
Series Disclaimer:
This series article is intended as a general guide and information only for beginners exploring cryptocurrencies and DeFi. The content of this article should not be construed as legal, business, investment or tax advice. For all legal, business, investment and tax implications and advice, you should consult your advisors. The Defiant is not liable for any lost funds. Please use your best judgment and exercise due diligence before interacting with Smart Contracts.
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