“DeFi” refers to the sophisticated new cryptocurrency ecosystem that emerged in force this year, consisting of useful, interoperable blockchain applications, rather than the standalone coins that have dominated the cryptocurrency space to date.
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And “yield farming” refers to a way of utilising (some would say exploiting) these systems for the purpose of very quickly making jaw-dropping, eye-watering, loin-girding amounts of money.
How about up to 2,400% APY equivalent?
Still not enough? Well, there’s also 26,000% per year returns if you’re into that kind of thing.
Kimchi returns used to be as high as the 200,000% range, but it’s settled down a bit since then.
This has got to be some kind of scam
A wise person once said: If it’s too good to be true, it is.
That’s the case here, in a way, but it’s not necessarily because these are outright scams.
For clarity, it’s worth emphasising that many of these types of cryptocurrencies with insane returns absolutely are total scams, and you will be fleeced if you risk any funds in them. But it should also be said that just because the returns are ridiculous, doesn’t automatically mean it’s a scam.
It can be difficult to understand, even for farmers.
Show me the (source of the) money
Let’s focus on SushiSwap as a case study. It’s the one currently delivering humble returns of around 2,000% APY equivalent.
There are three factors coming together to deliver these yields:
- The token. The returns are being paid in newly-created SUSHI tokens rather than “real money” so no one’s actually losing money by paying out these yields.
- The inflation rate. These returns are temporarily supercharged in an effort to distribute these tokens more widely. The token inflation rate is currently sky high, but the amount of SUSHI tokens being awarded will get cut to a fraction of its current rate in roughly a week from the time of writing.
- The market. The SUSHI token market has so far been able to absorb this insane rate of inflation without crashing. If the SUSHI price suddenly tanks to 10% of its current price, the real rate of return will also drop to 10% of its current rate.
- The participants. The fewer people there are participating in a farm, the higher the rewards they get. As more people join, the rewards drop.
So at the end of the day, these returns are coming from the same place as Bitcoin’s historical gains. The source of the money is everyone who buys these tokens off the market, shoring up prices in the process.
By design, these returns are not sustainable. It’s just a temporary incentive to attract users and boost growth. At the end of the day the real question we have to ask ourselves is how much the SUSHI token is actually worth and whether it will be able to justify continued high prices.
We can look at the same three factors – the token, the inflation rate, and market supply and demand – when assessing other yield farming projects.
If the token is gearing up to be worthless, the losers are anyone who bought and is left holding bags of that token. This has happened many times already, with other food-themed cryptocurrencies such as HOTDOG and PASTA crashing and burning their buyers.
So, as unbelievable as it seems, these are not always scams and the returns are not necessarily too good to be true. Pick at random and you’ll probably find a scam, but choose wisely and you might be onto something.
A full explanation of the SUSHI token and a price prediction is beyond the scope of this article, so if you’re interested you’ll have to do your own research on that front. But suffice it to say, SUSHI does not appear to be an outright scam, and its token appears to have a coherent value proposition.
All that said, it certainly doesn’t mean any of this is necessarily a good idea. It’s not low risk by any stretch of the imagination. Buying these kinds of coins is a good way of losing money fast and if you just pick yield farms at random you’re far more likely to find a scam than a good bet.
With all that in mind though, it’s also not automatically a bad idea in every case to dabble in something delivering unbelievably high returns, and it’s not necessarily too good to be true.
The risks in yield farming
Yield farming in general is sufficiently risky that you should be prepared to lose any funds you put towards it. Don’t spend or deposit more than you’re willing to lose.
Beyond those general risks, there are more specific things to look out for as well. Once again, we’ll use SUSHI as a case study for assessing the two big risks: market collapse and smart contract failure.
The risk of market collapse
The most immediate risk when gambling on SUSHI, and many other tokens, is that you buy some, the price tanks and it turns out you’ve thrown some money at a worthless food-themed cryptocurrency.
To add insult to injury, everyone you tell about it will then say something like “The token is named SUSHI. I can’t believe you wasted money buying such obvious garbage.”
Fortunately, farmers don’t actually need to buy any. Anyone with the right underlying cryptocurrencies can start farming SUSHI tokens for free, so a good step to reduce the cost of a market collapse is to stick with being a farmer rather than a buyer.
Unfortunately Ethereum gas prices are exorbitantly high right now, largely because everyone is so busy farming these goofy food tokens. So while farming is nominally free, in practice any prospective farmers must be prepared to spend several hundred dollars worth of ETH on gas, at a minimum. And anything more than dabbling can quickly run into gas fees of thousands of dollars in total.
On paper, a good first step to reduce the chances of making a terrible money mistake is to stick to being a farmer rather than a buyer. But in practice, trying to tap these magic money machines carries significant up front costs regardless of how you do it, along with a major chance of the token market abruptly collapsing.
There are many reasons for the market to collapse. If the whales get bored, if it turns out to be a scam, if there’s an unexpected bug or if a project just doesn’t go as planned, it could all go to zero.
This risk can be partially mitigated by choosing to farm a token that’s guaranteed to perform well. Unfortunately, these don’t exist.
So with the high upfront costs, even for theoretically free farming, and the high chance of sudden market collapse, yield farming in general is on the ludicrously high risk end of the spectrum.
The risk of smart contract failure
Yield farming is built on a framework of blockchain smart contracts. They’re basically public, open-source programs that anyone can use.
In theory, anyone can check how they’re programmed to make sure there are no hidden back doors, bugs, vulnerabilities or other nasty surprises. But in practice this isn’t always easy or reliable.
Firstly, because this stuff is complicated. Even if a contract appears to be safe, there could be a fatal bug or scammy backdoor that evades detection until it’s too late.
Secondly, because there’s no guarantee that anyone is actually checking the contracts thoroughly. Unless you’ve personally checked them, or you’re satisfied that a smart contract has been formally audited, you can’t assume that a yield farming smart contract is safe to use.
You could wake up one morning and discover that your entire yield farming crop has burnt down overnight and all your money is gone.
High risk, high return
As you can see, yield farming has an extremely high chance of going wrong. It’s almost guaranteed to involve significant costs on your end and there are many exciting ways to lose all your money without recourse.
Furthermore, the barriers for entry are high. Other than gas prices, a decent amount of crypto and DeFi know-how is essential for anyone thinking about getting involved in yield farming.
The returns are not sustainable and the vast majority of these stupid cryptocurrencies will go to zero, dragging down many unfortunate victims with them. The only reason so many coins can generate such high yields is because the crypto markets are habitually over-hyping these coins without properly pricing in the insane amounts of risk involved.
The space is rife with scams, and even if you manage to avoid those you’re still left farming coins that will probably fail in the near future.
To call it a disaster waiting to happen is an understatement given how many of these kinds of coins there are and how interconnected the nascent DeFi ecosystem is. It’s more like five dozen interconnected disasters waiting to happen simultaneously, like a hurricane striking a nuclear waste dumping ground in the middle of an earthquake.
In short, it’s a fairly reasonable balance of risk and reward for some, especially if you manage the risks in such a way as to massage the odds in your favour.
The main takeaway is that these ludicrous yield farming returns are not necessarily too good to be true. It’s actually quite clear where all the money is coming from, and there’s nothing particularly impossible about any of it.
While scams are common, it’s only because scams naturally pop up any time you get lots of humans and money in the same environment, not because there’s anything innately scammy about yield farming.
At the end of the day though, the main reason the yields are so incredibly high is because most people reading this will not start yield farming. It’s difficult, expensive, extraordinarily risky and very likely to go wrong. Hence the high returns.
Disclosure: The author OWNS cryptocurrencies including SUSHI at the time of writing.