Yield farming: We need to de-risk yield farming to attract more individuals and institutions to DeFi, says Tranchess co-founder Danny Chong.
Yield farming in Decentralized Finance (DeFi) has long been a high-risk, high-reward endeavor. However, high risks can also dampen investor confidence and prevent new entrants from entering the market. DeFi players should consider taking effective action to address this in preparation for the next wave of DeFi growth.
DeFi growth
It was 2020 when the DeFi summer officially began. Thanks to Compound, MakerDAO and Uniswap helping to catapult the market, DeFi has become a significant crypto segment catching the attention of the mainstream financial market. As more engineers update and strengthen the current architecture of products and protocols, we also see greater participation from mainstream institutions.
Recent examples include the world’s largest wealth manager, BlackRock, adding crypto services, accounting firm KPMG Canada adding crypto to its balance sheet, and Ontario Teachers Pension Plan investing in crypto investment firm FTX. Tesla, no stranger to bitcoin, announced that it held nearly $2 billion worth of bitcoin at the end of 2021, reiterating its continued belief in bitcoin’s potential. From what we’ve seen, it’s likely that financial institutions will continue to invest in digital assets in 2022. But as more crypto invests and holds, are they ready to embrace DeFi?
Various solutions have emerged as early answers to the high risk in yield farming. Products like Binance Custody, a Centralized Finance (CeFi) platform, provide a platform aimed at meeting regulatory requirements and could serve as a rite of passage for institutional types entering a high-risk DeFi environment. Institutions willing to dip their toes into DeFi can turn to Aave’s Arc, an approved DeFi protocol compliant with AML regulations and KYC and KYB verifications. However, this is only the tip of the iceberg – much more needs to be done. For the industry to be fully mainstream adopted, we need to take steps to ensure the right entry points for yield farming are available.
Manage high-risk exposures in yield farming to welcome more institutions
Yield farming is an attractive investment strategy as it offers users a high return on investment without minimal or high capital requirements. Smart contracts put capital into a liquidity pool and in return, liquidity providers receive a native reward. However, yield farming is far from accommodating to the uninitiated. It’s not common for platforms to cater to different investment profiles, specify risk levels, or provide guidelines on where investors should allocate their capital.
While yield farming can be viewed as investing in a number of different businesses, it offers an opportunity to earn more faster than traditional businesses. So how can we as an industry help reduce risk, which in turn will attract more individuals and institutions to DeFi?
yield farming: Protocols for introducing new revenue models to mitigate risk
The total value locked (TVL) in DeFi protocols is just under $200 billion, according to DeFi Llama, compared to the total market cap of the US stock market of $53 trillion, suggesting that DeFi is still in its infancy. The potential to grow into one’s own financial framework is comparatively large.
Essentially, new value in DeFi involves the printing of “future money” through token issuance, which means the release of new tokens. The more these tokens are acquired by the market, the higher their value increases. This is similar to a stock model, where more value is generated when people believe in a company, or in this case a protocol, and what it stands for. Many protocols today still rely solely on native token issuance, but there are protocols trying to make DeFi less risky. This is achieved by adopting different revenue models for more stable and consistent returns.
Some of these protocols include Ankr and Tranchess, which generate revenue by performing a BNB (formerly Binance Smart Chain) chain validation service alongside executing yield farming strategies. By introducing alternative sources of return and revenue models, users would be less likely to switch to other protocols as they are confident in the greater value of their investment in the protocol due to the focus on increasing revenue. This also better protects them from DeFi’s volatility and broader impact on financial markets.
Both DeFi and TradFi need to converge to stay relevant
As more financial institutions adopt crypto in some form, we are seeing the gradual acceptance of crypto in the mainstream. However, much of Traditional Finance (TradFi) still operates in a status quo in terms of what it offers to clients. Some have made strides in adopting fintech solutions that offer a more seamless banking experience to a larger number of customers.
However, much remains to be done. Aside from providing customers with better user experiences and access to crypto assets, institutions should give users access to high-yield opportunities through DeFi. For example, users can deposit the UST stablecoin on the Anchor protocol for 19% Annual Percentage Return (APY), as opposed to a traditional thrift account that offers interest rates below 1%. Introducing the most compelling products would give institutions a competitive edge and prevent TradFi from becoming like the telcos of finance, unable to offer differentiated and competitive offerings.
On the other hand, the DeFi industry needs to make a concerted effort to create a new business model with stable and sustainable returns.
yield farming: I’m looking forward to
DeFi is here to stay. As new financial investors enter the market, those who have already dipped their toes will continue to dig deeper into new protocols, chains, Layer 2 solutions, and technical upgrades.
For this path to be sustainable, DeFi protocols must make their offerings more risk-free, strengthen the underlying technology, and maximize security through audits and other measures (e.g. their portfolios. When TradFi and DeFi converge, they will bring together a mix of expertise and experience driving progress while being informed by ever-evolving regulations, all of which will reassure the mainstream that DeFi is a viable and valuable option to generate sustainable returns.
About the author
Danny Chong is co-founder of Tranchess, a decentralized, yield-enhancing asset tracker that offers stable and diverse high-yield returns to users with different risk capacities. With over 16 years of investment banking experience, Danny previously held senior trading, sales and management positions at leading French banks including BNP Paribas and Société Générale for the APAC region.
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