Why Decentralized Finance Has Extremely High Yield But Isn’t Mainstream “Yet”

At least 10% APR made possible for anyone that holds a National ID or passport. No other requirements needed. But?


Before The Long Story, A Quick Takeaway

First, Why Decentralized Finance?

DeFi — The Decentralized Finance Leaderboard at DeFi Pulse

Demystifying Decentralized Finance (DeFi)

  1. Stable Coin: A type of cryptocurrency with little price fluctuation. Usually 1:1 pegged to existing dollars such as USD. Examples include USDT, USDC, and DAI.
  2. Decentralized Exchange (DEX): A platform that lets allows users to exchange tokens through direct interactions with smart contracts. This minimizes the risks of funds stolen by malicious intermediaries. Examples include Uniswap and Sushiswap.
  3. Liquidity Provider: A type of user that provides liquidity to decentralized exchanges. Decentralized exchanges often face a problem: “how can I make sure that there are enough different types of tokens to be exchanged?” To solve this, they give financial incentives to those that are willing to put their tokens into a “liquidity pool” for others to exchange. Usually the gain is calculated from the trade volume of the provided token.
  4. Lending and Borrowing Market: Due to the high volatility of cryptocurrencies market, many users are willing to borrow money with high interest rate for leveraged trading. Another group of risk-averse people would be happy to lend money with the high rate. Examples include Compound, MakerDAO, and AAVE.
  5. Collateralized Debt: Use a cryptocurrency as the collateral to borrow another type of cryptocurrency. Usually the collateral ratio is higher than the value of an asset one can borrow. For example, to borrow 100 USD of asset A, one must deposit 150 USD of asset B. If the price of asset B drops below the collateral ratio (say 149 USD), asset B may be forfeited and the borrower ends up losing 49 USD.
  6. Flash Loan: This is a new type of loan that one can borrow money by just paying the transaction fee and not the collateral. This is only made possible because of the atomic characteristic in blockchain transactions. A transaction can either be valid (cause changes to the blockchain) or failed (nothing happens). If one can borrow money at the start of the transaction and return the money before the end, there would be no risk for the lender. Thus, the only cost of the borrower is the fee to submit the transaction. Example platforms include AAVE and dYdX.

What is NOT Good About DeFi

  1. Always beware of the URL you are visiting. Double confirm that this is not some spammy, cloned website that will transfer all your funds away once you approve it to control your tokens. My golden rule is to find the company’s Twitter account (the one with the most followers). The official URL is often included in their bio section.
  2. The returns are usually fluctuating. Sometimes we are overly optimistic about the high APR shown in new DeFi apps. However, that may only last for a week and then drop sharply. No pushed notifications for the dropped return, you must remember and carefully monitor it.
  3. Count the gas price into your total earnings. You may think that frequently switching to DeFi apps with a higher yield is the optimal strategy. However, each operation on Ethereum has gas costs. Gas price on Ethereum can be really expensive. Sometimes even higher than your total interests gained! The gas price is also not a fixed value, it becomes higher when the network is more congested. Check the gas price here.
  4. Make sure which currency the high APR is paid in. When you see numbers like 3000% APR, usually the reward is paid in some new token with little or diminishing value. That means, although you have 3000% APR and the amount of your asset C becomes 30 times in a year, the value of asset C may be dropping from 1 USD to 0.000001 USD within a year, and you end up holding a lot of zero-valued tokens.
  5. Becoming a liquidity provider? Do you know the impermanent loss? Being a liquidity provider doesn’t guarantee all positive gains. To provide liquidity, you often need to deposit two types of asset simultaneously. If the two asset’s price ratio changes dramatically, you will bear more impermanent loss. Calculate your impermanent loss here.
  6. Remember all the different platforms you locked your tokens in. These DeFi applications I mentioned above are independent from each other. A single portfolio in one app does not show the other. One solution is going to another app that summarizes all the tokens you locked in different platforms, like Zerion (see below screenshot). However, if one of your tokens is not supported in this platform, you are not able to see it. Currently I didn’t find a single platform that properly shows all of my locked assets in different DeFi apps. I have to manually keep a record of which platform has how many amount of each token. The platform also doesn’t show your earnings as a liquidity provider.
from Zerion — Invest in DeFi from one place

A Real Life Example

from Zerion — Invest in DeFi from one place
From SushiSwap Discord support channel
  1. First, you need to transfer your token from a centralized exchange (or any other places where you bought the token) to your crypto wallet with a DApp browser that allows you to interact with the DeFi app.
  2. Visit Sushiswap (two URL popped up when I searched for this name, so it took me a while to understand the difference between sushiswap classic and sushiswap.fi) and find your token pair at https://sushiswap.fi/pairs.
  3. Before adding liquidity, you have to “approve” the token. After approving, you can finally “supply” the token, which gives SLP (Sushiswap Liquidity Provider) token in return as a proof of your stake.
from https://sushiswap.fi/pair/0xfb3cd0b8a5371fe93ef92e3988d30df7931e2820
from https://sushiswap.fi/onsen
from https://sushiswap.fi/onsen

Total cost

from Zerion — Invest in DeFi from one place
from https://sushiswap.fi/omakase

Wrap up



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李婷婷 Lee Ting Ting

Founder of Z Institute | Blockchain dev & security audit | Berkeley Blockchain Lab | HKUST | IG: tinaaaaalee | Github: tina1998612