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Yield Farming and Aggregators – Yearn.finance

What is Yield Farming?

Yield farming is the practice of staking or lending assets to generate a return, This can be in either the same or a different asset.

Yield Farming is lucrative but labour-intensive for a user. Protocols such as Yearn exist to make life easier. They find those yields to give the user a strong return with minimal effort. It can also offer a tax benefit.

Earning interest on crypto

If you hold ETH, its price might rise or fluctuate in USD. However, it isn’t accruing interest, as the amount of ETH remains unchanged. You can deposit that ETH into a borrowing platform like Aave or Compound. The %APR that is earned on top of your deposit is the yield your initial crypto-asset generates.

Yield Farming your crypto crops

This is “farming”, because much like a farmer plants multiple crops, most DeFi investors are “planting” multiple assets across different platforms. When they are ready, they can “farm” (harvest) those generated yields.

Besides a Borrowing and Lending platform, contributing to Liquidity Pools (LPs) on a Decentralized Exchange (DEX) such as Uniswap is another method to yield farm, but comes with the risk of impermanent loss.

While there are many ways to yield farm, the key takeaways are:

  • Yield farming is the process of earning a return on capital by putting it to productive use
  • Borrow platforms offer the simplest way to earn reliable yields on your crypto
  • Liquidity pools have better yields than money markets, but there is additional market risk

Actively managing multiple positions and platforms can be exhausting, and not everyone wishes to do that. That is where yield aggregators come in.

Yield farming Aggregators: Set it and Forget it

A yield aggregator finds the yield farms for you, removing the burden of work from the user. Let’s use Yearn’s USDC vault as an example:

  1. Alex has USDC and wants to yield farm, but doesn’t want to invest time or the gas required to do it properly.
  2. He takes USDC to Yearn, a yield aggregator, and deposits it into the USDC vault.
  3. Alex receives yUSDC in exchange for the deposits.
  4. Yearn’s smart contract deposits the USDC that Alex and other DeFi users deposited in the vault across different protocols and strategies to earn more USDC that goes back into the vault for depositors like Alex.

Now it’s important to understand the role yUSDC plays in the system. When Alex transfers USDC into the vault, yUSDC acts as a sort of receipt token. Its value is representative of the proportion of USDC that Alex owns in the vault. yUSDC is a yield-bearing token, it creates additional income (yield) on top of what was deposited.

Yield Bearing and auto-compounding tokens

Yield bearing tokens create auto-compounding yield. When Alex deposits USDC, the vault mints yUSDC and sends it to Alex’s wallet. When the vault generates yield from its strategies and the earned USDC enters the vault, it does not generate new yUSDC, increasing the value of all the minted yUSDC.

Let’s use the simplified example below:

  • Alex Deposits 100 USDC into USDC vault, mints 100 yUSDC.
    • 1 yUSDC = 1 USDC b/c 100 yUSDC / 100 USDC in vault
  • Vault earns 100 USDC from yield strategies and it enters the vault. No yUSDC is minted
    • 1 yUSDC = 2 USDC b/c 100 yUSDC / 200 USDC in vault
  • If Alex now deposits 100 USDC, they will only receive 50 yUSDC so the ratio remains unchanged, but it is still indicative of the underlying USDC value
    • 1 yUSDC = 2 USDC b/c 150 yUSDC / 300 USDC in vault
  • If Alex exchanged the 25 yUSDC for 50 USDC it would be burned (removed from supply) to maintain the same ratio
    • 1 yUSDC = 2 USDC b/c 125 yUSDC / 250 USDC in vault

Yield farming and taxes

Yield bearing tokens let users accrue interest on their deposited assets without having to manually collect those returns. The value of the token increases over time. This is not only a very easy way of letting your assets appreciate, but it can also offer tax benefits. In many countries, the act of manually collecting yield is a taxable event, but gaining by owning an appreciating asset normally isn’t.

With Yield aggregators, an investor is able to expose themselves to many of the opportunities that yield farming in DeFi has to offer, all through the interface of a single protocol. While it might provide a lower yield than manually chasing the highest APYs offered, protocols like Yearn offer a less network and labour-intensive option for the end-user.

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