22 June 2022

Why Sustainable Yield is Better than High Yield

A look at the risks associated with high yield farming and how sustainable yield provides a more stable option for the future.

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Why Sustainable Yield is Better than High Yield

    Index

    How Yield Works
    Risks of High Yields
    Why Sustainable Yield is Better than High Yield
    TL;DR

As Decentralized Finance (DeFi) has taken the crypto world by storm over the past couple of years, yield farming has become one of the most popular ways to earn yield on your crypto holdings. Yield farming is the act of staking or lending your crypto assets to receive interest payments, and with the recent boom in DeFi protocols, there are now many yield farming opportunities available.

Defi yields are different from bank yields in one primary way—they pay out yield through generally decentralized protocols. This yield is earned through a yield-generating activity like staking, providing liquidity, or participating in a governance token’s voting process. This is categorically different from banking yields, which are earned through centralized entities like banks or government treasury bonds.

These DeFi protocols promise mouth-wateringly high yields, most in the range of 4-10% with some as high as several hundred percent yields. However, these yield farming opportunities often come with high risks, and many of them are not sustainable in the long term.

How Yield Works

On a very basic level, yield is simply the interest you earn on your crypto assets. When you stake your crypto in a yield-earning protocol, you are essentially lending your crypto to someone else and receiving interest payments in return. The amount of interest you earn depends on the yield protocol you are using, the length of time you stake your tokens, and the number of tokens you stake.

The yield you earn can either be fixed, meaning you will earn the same amount of interest each day, or it can vary based on the performance of the protocol. For example, some yield protocols will give you a higher yield if the price of the underlying asset goes up, while others will give you a lower yield if the price of the underlying asset goes down.

Yield payouts come from the fees that are charged to users of the protocol. For example, when you borrow crypto from a yield-earning protocol, you will usually be charged a small interest fee. This interest fee is then used to pay out yield to the people who have staked their crypto in the protocol.

Risks of High Yields

The biggest risk of yield farming is that the yield you are earning is not sustainable in the long term. Many yield protocols offer high yields for a limited time only, and when the yield drops, people often move their crypto to another yield protocol that offers a higher yield. This can create a situation where yield farmers are constantly chasing higher and higher yields, and farmers may take their stakes out of the protocol, causing a cascade of sell orders that can crash the price of the protocol’s token.

Another risk of yield farming is that the protocols you are staking your crypto in may not be stable or secure. Many yield protocols are still in their early stages and have not been well tested. This means that there is a risk that the protocol could fail or be hacked, and if that happens, you could lose all of the crypto you have staked. There's no shortage of bugs, hacks, and exploits in the crypto world, and DeFi protocols are no exception.

The third risk of yield farming is encountering high gas fees (the fee you pay when you send crypto transactions). Some of the DeFi protocols that are most popular in today’s market charge high gas fees and can make moving your crypto around or claiming your rewards quite difficult. This can be a real hassle if you need to move your stake quickly as the gas fees can eat into your yield earnings.

Why Sustainable Yield is Better than High Yield

When comparing the risks of yield farming to the benefits, you will find that all things being equal, it is better to hold your crypto passively instead of farming for high yield because your crypto is less at risk. In an industry where high risk is the soup du jour, it is often more prudent to take a more cautious approach.

With lower, more sustainable yields, the systemic risk is much lower because yield farmers are not constantly moving their crypto around in search of a higher yield—it's unlikely liquidity providers chase the high of low yields.

For example, a company like Coinbase or Gemini might offer a 5% yield on Bitcoin and Ethereum deposits. The yield is sustainable because it comes from the revenue that these companies generate from their businesses, like transaction fees or interest on their reserves. The yield is also predictable, so you generally know exactly how much interest you will earn each day, week, or month. The yields are not dependent on flippant yield farmers who might take out and add their stakes based on yield changes. And as such, because the yield is sustainable and predictable, it does not create the same volatility in the market that high-yield farming does.

TL;DR

  • A lower, sustainable yield is better than a higher yield because it is less risky. Yield farmers are constantly chasing higher yields, which can create a situation where they take their stakes out of the protocol, causing a cascade of sell orders that can crash the price of the protocol’s token.
  • With sustainable yield, the risk is much lower because yield farmers are not constantly moving their crypto around in search of higher yield.
  • Companies and protocols that offer lower yields tend towards more systemic stability because you can generally count on the yield and know that you will receive it, as opposed to higher yields that rely on yield farmers to continue providing them.
Please be aware that: Cryptocurrencies are unregulated in the UK; Cryptocurrencies are not protected under Financial Ombudsman Service or Financial Services Compensation Scheme (FSCS); Profits may be subject to capital gains tax; The value of investments can go down as well as up.

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