- There are different types of yield farming protocols based on utility and staked tokens.
- David Malka describes the variations and the due diligence investors need to do before trying it.
- Huge yields, a lack of utility, or low total value deployed are red flags.
On August 27, 2021, David Malka, a stock trader for seven years, played a game of Musical Chairs. But instead of risking his spot, it was more like risking the shirt off his back.
He was yield farming, an application of decentralized finance, or DeFi, that pays out yields in exchange for depositing crypto into a shared pool. In this case, Malka was on a very new and risky protocol called Frost Finance. So he decided to film himself trying it out.
Frost Finance was offering outrageous APRs of 37,000% to 47,000% at the time of writing. Was it a Ponzi scheme? Definitely, said Malka. In a typical Ponzi, the investor pays hefty “returns” from a shared pool of all customer deposits.
But why did Malka do that? First, he claimed to have made about $14,000 worth of Tundra, the platform’s native cryptocurrency, in one hour. During the nine-minute video, he made about $1,000 in seven minutes. A Tundra was trading just under $7,000 at this point.
Second, he’s a player – literally. Malka played professional online poker for about seven years, winning tournaments like the 2016 Seminole Hard Rock Poker Showdown, which netted him $658,000. So when it came to this high-stakes protocol, he took it like a gamble.
“You have to buy an entire shitcoin, deposit it in this yield farm – it’s going to give a really big return,” Malka said. “And then eventually people will take all their profits from this yield farm and sell this shit coin as soon as possible.”
The video shows him weaving in and out of the protocol using Tundra paired with a crypto called Wrapped AVAX. Every time he noticed high selling pressure, he threw his bag away. Malka told Insiders he did this for about six hours before taking his earnings and exchanging them for USD coins.
As for Frost Finance, the music finally ended and all the chairs were gone. The price of the tundra crashed and burned. In January it traded below $1. On Monday it was $0.53.
Malka, who is now the CEO of Yieldfarming.com, an educational platform that educates users about yield farming, says there are probably thousands of these types of programs out there that are useless. They offer very high yields that are unsustainable and create inflated, short-term demand.
“Eventually the selling pressure overwhelms the buying pressure and the music stops,” Malka said.
For the time being, Malka is still playing along. According to a screenshot of his account with Koinly, a crypto tax tracker, he has a cost basis — or original value — of about $777,800 for yield farming as of Oct. 24, 2021. His profile on DeBank, a DeFi platform tracker, showed a total value of about $2.5 million on Tuesday, meaning he had won over $1.5 million.
Tony Dhanjal, head of tax at Koinly, looked at both documents and said that DeBank’s total value accurately reflected the value of its portfolio. Dhanjal said in an email to Insiders that the numbers above represent the best information available to measure the return on his investment.
Most of Malka’s earnings from yield farming came from risky protocols – this approach may not be for beginners, especially at a time when token holders are seeing heavy losses in their portfolios. He has also deployed assets across a variety of platforms that require regular monitoring. Some of the underlying cryptocurrencies are volatile, having fallen as much as 90% year-to-date. This also affects the overall value of his winnings.
Not all yield farms are the same
Yield farming protocols are not all Ponzi schemes or risky.
Hannes Graah, the founder and CEO of Gro, a company that makes products that combine DeFi and traditional technology, says that to be sustainable, a project must provide value. Typically, these platforms provide liquidity for lending protocols or trading on decentralized exchanges. As a participant, you contribute crypto to this liquidity pot.
Malka said that while yield farming isn’t all that useful, at a high level it allows you to be the bank. Traditional finance requires an intermediary, such as a bank or stock exchange, to provide liquidity and execute transactions. In DeFi, this intermediary is replaced by smart contracts, while the lenders are decentralized users earning the interest.
Dan Reecer, chief growth officer at Acala, a platform building DeFi protocols including yield farming, says yield farming is more of an early marketing expense for user acquisition than something permanent. The intent behind the high rewards is to keep users on the platform once the rewards end.
“It depends on the tokenomics of each project, but typically it’s some kind of campaign with a temporary or fixed duration,” Reecer said.
Malka agreed with this statement, but described the approach as no different than a company giving customers loyalty points to encourage them to use their credit card. However, Malka added that cryptocurrencies like stablecoins are an integral part of DeFi protocols, so while returns can be reduced over time, they are very rarely eliminated.
Lowering the risk
Malka started yield farming in Spring 2020 to generate a market-neutral return, a strategy that aims to reduce a portfolio’s risk by generating returns that are independent of the market. In the case of traditional shares, this can correspond to a bond. In crypto, the approach works best with stablecoins like USDcoins or Tether as they are pegged to the value of the dollar. About 30% of his wagered assets are in stablecoin protocols, he said.
Graah said depositing a stablecoin in a credit log is probably the most conservative approach to yield farming. It has very limited risk because you are not betting on the price movement of a specific crypto asset, he added.
But that doesn’t mean investors aren’t taking risks. Graah pointed out that even within stablecoins, there is a wide spectrum. On the one hand, coins can be backed by the dollar and checked regularly. On the other hand, they can only be supported by an algorithm.
Malka noted that stablecoins that are not fully backed by the dollar are at risk of being depegged, which means their value can drop below $1.
“For every issue of USDC, they deposit $1 into the bank account. Somehow, when USDC sells a lot and it drops to around $0.97, they can literally withdraw money from their bank account and buy USDC back $1. So that’s an example of temporary depegging,” Malka said. “But a riskier stablecoin like USDT [Tether], it is not supported one-to-one. So when it’s down to $0.75, they can’t really withdraw dollars from the bank account and buy it back down to $1.”
On Saturday, UST broke away from terra as it plunged to $0.90 in response to high selling pressure. By Friday it had not recovered.
Another risk Malka pointed out is a rug pull, which he described as developers of a protocol simply stealing your money by withdrawing large sums of crypto from the pot and sending it to their wallets.
Finally, Malka said, there is a risk of exploits or hacks through vulnerabilities in the smart contract. Malka pointed to the hack of Wormhole earlier this year, a bridge connecting Ethereum to the Solana blockchain. Hackers walked away with $320 million.
Reecer highlighted the increasing number of anonymous or “undoxxed” teams behind DeFi projects as a red flag that obscures whether the teams and developers have relevant experience.
What to consider before yield farming
While there’s no way to guarantee safety, Malka says investors should do three things before trying a yield farming protocol.
First, become familiar with a metric called Total Value Locked, or the sum of all staked crypto assets within a protocol that are generating revenue. He recommends using a site called Defi Llama, a TVL aggregator that tracks the dollar value of coins deployed across different protocols.
Malka said that in general, anything over $1 billion in TVL is very safe, suggesting massive funds deposited their money in the log after doing their research. As an example, he pointed to Curve, which had about $16.4 billion in stakes as of Monday, according to Defi Llama.
He said a TVL of $100 million to $1 billion is medium risk, adding that once a protocol falls below $100 million in committed funds, it is high risk. For example, Tundra had a TVL of just $40 million.
Second, link a browser wallet like MetaMask — which is required to connect to these DeFi protocols — to a hardware wallet rather than a centralized exchange.
Third, navigate to the protocol’s website and read through the documentation. Malka said they are specifically looking to see if the project has been audited, which means a security firm has scanned the smart contracts on the platform for vulnerabilities. Ideally, you want to see multiple audits, Malka said.
“If they have audits, and if you click on the audit and actually read it and make sure they don’t have any critical points, then that’s generally a good indicator that the log is pretty secure,” Malka said.
He added that if you want to dig deeper, check out who the reviewers are and how many other notable protocols they reviewed. He said there are about 10 reputable companies including CertiK, Trail of Bits, Quantstamp, Paladin and OpenZeppelin.
Overall, Malka’s biggest tip is to start small. Set up a MetaMask wallet and a hardware wallet, then deposit just $100. Move that amount to a yield farming platform like Avee or Curve, wait a few days to start earning returns, and withdraw your profits and capital. Do this a few times before increasing your position.
Reecer added that if returns seem too good to be true, don’t take chances.
A widely highlighted problem with the structure of yield farming is what is known as impermanent loss, where the value of the token at the time of withdrawal is lower than when it was deposited. This happens when traders take advantage of asset price volatility and arbitrage crypto. If you are part of a protocol that provides liquidity to an exchange, the loss from the price difference comes from the yield farming pot. Depending on when the farmer withdraws his assets, the losses could hit him.
Malka said the losses are trivial for most yield farming positions because returns are typically greater than losses. He recommends using a free fickle loss calculator to determine the possible margins for each protocol.
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