Yearning DeFi

High contract fees on optimized lending platforms may be roadblocks for casual retail investors

I spent a good deal of time researching DeFi yesterday, mainly trying to figure out what the hell Curve and YFI are.

I’ve spent several months with deposits on BlockFI, where my crypto and stable coin assets are making between six and eight percent interest. It’s decent, compared to bank deposits right now, but I keep coming across these insane valuations on certain lending protocols, upwards of twenty five, sometimes as high as one hundred percent APY. What is going on, how risky is it, and how do I get in on the action?

Most of the lending protocols, take Compound for example allow users to deposit certain tokens, such as DAI or ETH, and receive interest on these deposits. Alternatively, users use these deposits as collateral for loans with which they can receive other tokens. BlockFI offers USD loans as well, at rates around nine percent.

I’ve never found a reason to participate on the borrowing side of these platforms. Apparently people use them to make short-term trades, possibly staking them on other platforms, but that’s been a bit risky and complicated for my tastes. I’ve stuck to the lending side of these platforms, becoming what is known as a liquidity provider, or LP. (I think it’s interesting that this acronym mirrors one from venture capital, for limited partner. The comparison is quite apt.)

One of the reasons that I settled on BlockFi for my deposits is that they are more aligned with traditional finance, and I feel a bit safer keeping my funds there than with a smart contract that could be susceptible to the usual risks such as code vulnerability. (See the DAO hack for an example of this.) The other is that they had higher rates than Compound and some of the other competitors. At least, they did.

And that’s where these newer DeFi protocols come into play. Curve is one smart contract platform that automatically maintains users’ funds in whatever system is offering the highest interest rate. This is done automatically whenever someone interacts with the contract by depositing or withdrawing funds. The advantage here is that LPs don’t have to deal with it manually and also save gas in the process.

The downside is that it is relatively expensive to interact with these contracts. I did a small test transaction today, exchanging LINK for Aave’s aLINK token, which I then deposited in a Yearn Vault. I paid almost $90 in gas between the two. Since the fee is flat and not based on the amount of funds, these types of systems are geared toward larger liquidity providers. (As of this writing, Curve had over $800 million in funds in its stablecoin liquidity pool.

Platforms like Aave, Curve, and Yearn are some of the most cutting edge in the DeFi space right now, and I’m just getting familiar with them. There is a lot of risk here, as we are talking about some uncharted space. Not only is there risk of contract failure and security audits that need to be done on these contracts, one tutorial described some of these governance token staking as the “derivative of a derivative of a derivative”. And I remember what happened in The Big Short.

I’m going to pause before I send any more funds into one of these platforms, until I can do some more research and weigh the options. This is clearly a space for large liquidity providers, and may be more than I am willing to risk at the moment.

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