Satoshi Nakamoto’s protocol for a peer-to-peer electronic cash system built the foundation for distributed ledgers known as blockchains. The rapid growth of our internet age and blockchain technology has given way to a lot of advancement in the system.
Decentralized finance (DeFi) is linked to the rise of cryptocurrencies. It marks the turning point for financial applications from the traditional custodial financial system that depends on middlemen and third parties.
With the launch of various new protocols mostly on non-Ethereum blockchains, DeFi has gathered massive interest in just a few short years. It is a rapidly growing ecosystem with active protocols and applications that deliver transactions and value to thousands of users as digital assets without the reliance on a centralized authority.
Unlike the traditional financial system, DeFi enables users to have adequate control over their money or digital assets through personal wallets devoid of third-party interference.
The fact that DeFi doesn’t need the approval or concession of intermediaries is just a tip of the ice berg. The appealing features lie in its flexibility and several other branches that all contribute to the growth and recognition it has gathered over the years.
It is on record that the total value locked (TVL) in DeFi has risen above $50 billion after falling below the range for the most part of March this year. At the time this article was being written, the TVL in DeFi is roughly $50.34 billion.
Before Yield aggregators came to light, DeFi users will have to move liquidity from pool to pool manually causing the process to be incredibly time consuming with high fees attached and it can be very stressful process too.
As a new branch of DeFi, yield aggregators play a huge and important role by leveraging various DeFi protocols and approaches to increase user profits in the yield farming economy. Let’s jump right into understanding the concept, importance, rewards and risks of yield aggregators.
What is Yield Farming?
Yield farming is a widespread field of DeFi that allows cryptocurrency holders to earn a return on their assets by lending, staking or locking them with yield aggregators.
It also involves staking cryptocurrencies in yield-generating smart contracts in order to receive rewards in the form of additional tokens which are mostly shared equivalently to the number of tokens staked by each user.
With this setting, the user or investor becomes the liquidity provider because they provide liquidity to a DeFi platform by depositing their cryptocurrencies and the liquidity pool becomes the money-filled smart contracts.
The automated market maker (AMMs) plays a vital part in yield farming because they enable automated trades between two assets, using a liquidity pool rather than a traditional buyer and seller market.
One of the main goals of yield farming is to capitalize or maximize returns on cryptocurrency holdings by taking advantage of several opportunities available in the DeFi ecosystem.
It is a newer and more experimental form of investing in DeFi that skyrocketed into popularity with the formation of the governance token of the platform’s lending protocol Compound widely referred to as “COMP”. Compound is a decentralized lending or borrowing protocol that allows users with newly-minted COMP tokens to earn interest or rewards on cryptocurrency holdings in a process called “liquidity minting”.
Users that participate in yield farming are then rewarded with the governance tokens to encourage their participation rather than being rewarded with interest when lending and fees when providing liquidity at the early adoption stage of the platform. And thus, these various reward forms shaped the basis for DeFi yield aggregators.
In as much as yield farming is gaining tremendous popularity, there are several risks associated with it. The smart contracts which are self-executing pieces of code that run on a blockchain possess a high risk to the yield farming protocol.
The high-profile hack of the Poly Network in August 2021, that resulted to the loss of over $600 million worth of cryptocurrencies, demonstrates the risks posed by the vulnerability of smart contracts.
Other risks associated to yield farming include: Liquidity risk, the volatile nature of cryptocurrencies, regulatory risks etc. We can then safely say that yield farming is a strategy that can generated high rewards and it also embodies high risk, proper research, management and careful considerations just like every other Cryptocurrency protocol or platform.
What is a DeFi Yield Aggregator?
Before yield aggregators, DeFi users will have to move liquidity from pool to pool manually first. This process made it incredibly time consuming, involved the use of high fees and made it very stressful.
Also called “yield optimizers” or “automated compounders”, yield aggregators present an automated rather than manual strategies. It involves investing assets in the combination of liquidity pools with varying risk levels so that they can automatically generate the best returns and rewards.
It can often return a much higher yield than traditional investment strategies. Yield aggregators, enhance the ways to get profit for maximum productivity in the system.
The users do not need to do anything, because the yield aggregator does everything for him with a certain percentage charged by the vaults for each automated compounding.
A DeFi yield aggregator platform, pools liquidity from different decentralized exchanges together so that users would not need to worry about the volatile nature of the market, so it basically assists users or investors in their quest to find the best return on investment (ROI) or increase the earnings for their cryptocurrencies.
Yield aggregators can also be seen as protocols or platforms that permits investors to stake their liquidity pool tokens in vaults where these vaults are further used to deposit liquidity into various different protocols thereby generating returns.
It aids users to save time, effort, and energy by automating the process of finding and executing yield farming opportunities.
Yield aggregators, also assists in risk reduction by spreading investments across several strategies and protocols, directly guaranteeing protection against losses in any single protocol.
How do Yield Aggregators Work?
What yield aggregators do, is that they leverage the opportunities available in the DeFi ecosystem in order to generate the highest possible yield for investors or users.
Instead of manually going to each platform to compare prices that would generate the best return, yield aggregators work by pulling up the best prices from decentralized exchanges, lending protocols, liquidity pools and bringing them together in one place so that users can enhance their trades.
It works, by automating the entire farming process so as to generate the highest yields. The users remain idle while the aggregators automatically distribute their funds into several yield farming protocols across different DeFi strategies.
The yield aggregators further monitor the performance of these strategies regularly and corrects the allocation of funds as needed to increase returns on invested capital, they are also responsible for re-investing interest gained on yields without the need users to do so manually.
Due to the fact that some of the tokens used by participants in yield farming are governance tokens, the users get to influence management decisions through voting.
These governance tokens also help in incentivizing the network’s activities. With these incentives, more fees, leading to higher deposited token yields are generated.
Yield Strategies
Yield strategies are ways through which protocols generate yields aside from auto-compounding. A popular yield strategy is to enhance liquidity on a DEX by providing liquidity to a trading duo, the traders provide an equal value of coins to the DEX, which locks the coins up as collateral.
The crypto deposited into liquidity pools earn yield from fees paid by traders for using their liquidity. Investors however, claim these rewards manually thereby acquiring a gas fee anytime they do this, which reduces their profits and affects their annual percentage yield (APY).
Through the strategy of depositing LP tokens into a farm which rewards the users in its native liquidity pool or single tokens, the yield aggregators automate the entire process thereby helping participants to save gas fees through staking their tokens in vaults.
These aggregators relieve the manual stress on the participants further by enabling automatic claiming of tokens, converting them into yield-bearing assets and re-investing or staking them back for a higher yield.
Yield aggregators make use of auto-compounding at precise intervals to increase yield farming rewards thereby boosting the overall staking APY.
The overall goal of yield strategies is simply to generate a consistent and higher return on investment (ROI) while managing risks and preserving capital.
Yield strategies, various investments can be made in different portfolio of assets across several sectors in bid to reduce risk that could be incurred on anyone of the assets that could affect the rest and enhance returns.
What yield aggregators does for users, can be likened to the same thing an automated device can do for a person. Yield aggregators automate the process of staking, collecting and re-investing in the pool with the drive to acquire maximum returns, and because this process is divided into batches, gas fees are shared among the users.
Apart from auto-compounding, there are several other ways on record through which protocols generate yields and some of them are: Spiral lending, Governance farming, Weighted liquidity provision etc.
Yield aggregator platforms
Yield aggregators are platforms that enable participants to stake their LP tokens in vaults. There are various popular yield aggregator platforms which although are all similar, differ in the blockchain they support, the DeFi protocols they utilize, their interest rates and gas fees could differ as well.
DeFi yield aggregators are stationed on Ethereum and Polygon, a careful evaluation to check the compatibility of the network of choice and blockchain that hosts their assets is required of the users.
Every DeFi aggregator makes use of a different combination of yield optimization tactics which invariably results to difference in APY rates for staking on different protocols.
Some of the popular yield aggregator platforms include: Yearn Finance, Harvest Finance, Convex Finance, Reaper Farm, Beefy Finance, Pickle Finance and so on.
Yearn Finance is one of the popular Ethereum based yield aggregators out there that can be accessed through Fantom and Arbitrum. Using a combination of liquidity pool staking, crypto lending protocols, and other yield generating protocols like Ethereum 2.0 staking, Yearn Finance formulates an enhanced yield strategy for each asset in order to generate the optimal APY rate for staking assets.
Yearn Finance makes use of straightforward vaults known as yVaults which carries a thorough description of which protocol it deposits into and how assets are used to generate yield.
Convex Finance differs from other yield aggregators because it only leverages the Curve Finance DEX (which by the way is an automated market marker). Launched in 2021, Convex Finance provides an opportunity for liquidity providers to boost their yield by using Curve Finance staking (CRV).
Rather than the users being required to stake their CRV tokens themselves, the platform does it for them. It offers a liquid staking solution for CRV that aids in boosting rewards for all users on the platform without the need to lock CRV, while preserving sufficient liquidity to help stokers exit their position.
Every user on this platform also CRV governance tokens. Convex Finance is deployed on Ethereum blockchain and is widely known as the best platform for the optimization of yield for long-term staking in curve liquidity pools.
Harvest Finance is a DeFi protocol that is powered by an Ethereum token known as FARM. Harvest Finance automatically allows users to generate more interest based on the terms of that specific pool with compounding interest through their own FARM liquidity mining programs.
Users deposit their crypto assets into a diversity of lending pools, these assets are then further used to provide liquidity to borrowers in search of loans from the protocol.
It also offers an attractive feature where users can take out loans against their deposited funds without having to collateralize funds first. It engages a lot of investment strategies to automatically deposit and manage user’s funds, relieving them from the stress of manually shifting through a myriad of DeFi protocols and pools.
It is basically a great tool to earn passive crypto income especially for beginners and non-tech savvy folks.
Beefy Finance aggregates liquidity pools from various DEXs deployed on popular layer-2 networks like Avalanche, BNB Chain, Cronos and a lot more.
This platform serves investors who aim to deploy an extensive net across multiple decentralized Finance protocols, in a bid to find the most profitable staking prospects for all assets which includes stablecoins.
Are DeFi yield aggregators risky?
Yield aggregators are a great tool that enables participants to boost their earnings automatically devoid of manual difficulties.
There are many benefits associated with DeFi yield aggregators. Transactions are done through a smart contract, capital shifts are done automatically, eliminating the need for users to transfer funds manually between protocols.
Users, should remember that these platforms are relatively new and as such could come with risks. It is important that users carry out personal researches to understand these platforms and the bumps involved as they come with enticing flavors and flaws as well.
Yield farming and aggregators are indeed new but fully functional tools of investments in DeFi, there are still technically adjustments and experimentations to be made in the future given the fast spread and growth of cryptocurrency.
The risks involved with lending and borrowing occurs when yield farming strategies put assets as collateral to borrow other assets.
In the cases of high utilization when a lot of lenders withdraw at the same time, a certain number of lenders might have to wait until some of the borrowers have paid back their outstanding loans. This is called “liquidity risk”.
There is a composability risk involved due to the fact that yield farming strategies are usually built upon a series of DeFi money legos. This could enable the explosion of threats like scams, bugs, malicious hackers etc. that could directly affect the price of the token.
Returns of a strategy are often determined by a lot of factors, this could create an unstable APY which could lead to divergence or impermanent loss for some strategies. Low trading activities in AMM, changes in the price of governance tokens (highly volatile funds) etc. all are considered risky and could be a serious concern to potential users.
One major risk associated with yield aggregators is smart contract risk. These platforms rely on smart contracts to automatically distribute funds, which means that if there is a flaw in the code, it can result to a lot of losses.
Every crypto investor is a risk taker by default because there is always the awareness that money could be lost if the network is breached, it has happened many times in the past and even presently.
Investors are required to effectively examine and carry out a thorough research on the platform or protocol they want to engage in with these transactions.
