Yearn Finance played a leading role in the decentralized finance (DeFi) boom in the summer of 2020. Running on the Ethereum blockchain, Yearn Finance deployed smart contracts to maximize returns on deposits and generate interest rates. high interest.
This process is called yield farming and Yearn Finance was a pioneer in the business. Let’s start with the origin of the protocol.
Origin and objective of Yearn Finance
Yearn Finance owes its existence to Andre Cronje, a South African coder who has created and contributed to over 25 DeFi projects. Many in the community refer to him as the “Godfather of DeFi”.
In early 2020, Cronje launched two DeFi projects – yEarn Finance and iEarn. The latter was the first decentralized application (dApp) to leverage smart contracts for return aggregation. The concept was simple:
- Users deposit crypto funds into a smart contract vault.
- The smart contract algorithm automatically allocates these funds to other smart contracts (DeFi platforms) with the highest interest rates (yields).
- Interest is paid by borrowers who tap into these coffers, just as customers go to banks to issue loans.
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In traditional finance, this approach would involve moving money between accounts to earn interest. In the DeFi world, there are no banks. Instead, smart contracts, hosted on blockchain networks, serve as depositories of liquidity for lenders and sources of liquidity for borrowers.
On either side of the equation, borrowers and lenders interact with smart contracts. After iEarn showed success in yield aggregation, Cronje renamed it yEarn, as in yield earning, which eventually morphed into Yearn Finance (YFI) in July 2020.
At its TVL peak in December 2021, Yearn Finance held $6.91 billion in crypto funds, an incredible 103,034% growth since July 2020.
Yearn Finance’s popularity reflects its core mission. The platform’s goal is to simplify the DeFi experience, so crypto investors don’t have to chase returns across dozens of lending dApps.
Interestingly, Yearn Finance is one of the few projects that has not been funded by venture capitalists. Moreover, Cronje has not even raised funds, private or public, through YFI token sales. To follow the spirit of decentralized finance, Cronje chose not to reserve any YFI tokens for itself.
Key advantage of Yearn Finance
Without Yearn Finance, investors would have to manually move their cash into the protocol that has the highest rate of return. As a talented programmer, Andre Cronje automated this process and extended it for public consumption in the form of Yearn Finance.
In addition to making DeFi accessible to the average online adventurer, Yearn Finance has rolled out a number of custom tools to serve as a yield aggregator for the biggest lending platforms: Aave, Curve, Balancer, and Compound.
Of course, liquidity providers (LPs) don’t have to just lend rigs to engage in yield farming. Decentralized exchanges (DEXs) like Uniswap require liquidity to trade token pairs, which also generates interest rates for liquidity providers.
With these YF tools, investors can buy the best interest rates available. To pay for the continued development of the protocol, Yearn Finance charges withdrawals, as a 0.5% fee.
Internal functioning of Yearn Finance
Yearn Finance is a collection of smart contracts working together to simplify yield farming. Each allows the aggregation of returns:
- APY: tags the annual percentage returns of lending protocols in the Ethereum dApps ecosystem
- To win: ranks the highest interest rates available
- Coffers: a set of trading strategies within staking pools
- Zapping: execute the set of trading strategies from the vault
The end user sees these four YF pillars, laid out like an intuitive news site. When connected with the MetaMask wallet to the Yearn Finance platform, the account wallet is front-end, displaying holdings, income and estimated annual return (APY).
Just below the user’s portfolio, Yearn Finance displays the three highest APY opportunities, like its version of the “trending” midsection. Below these high incomes is the list of all yield farming opportunities in dozens of vaults, filterable by total vault assets and APY.
Vault is the cornerstone of Yearn Finance’s model. Yearn Vault is a smart contract that collects cash from investors, but from other platforms. To make this inter-dApp connectivity possible, yTokens represent pools of liquidity (the tokens themselves are smart contracts).
Remember that when one deposits liquidity into a liquidity pool, such as ETH/USDC on Aave, the liquidity provider (LP) deposits those tokens as is to earn returns. A Yearn Vault is also such a yield-generating staking pool, but yTokens turn deposited assets into yTokens.
In other words, they are packaged as yTokens so that other smart contracts, on other platforms, can be accessed from a single source of aggregation – Yearn Finance. Similarly, when withdrawing funds, they are returned in the form of yTokens. For example, the Curve stETH vault, at 6.56% APY from Curve Finance, represents the Curve liquidity pool holding staked Ethereum (stETH).
When cash is deposited into a vault, the user enjoys yield benefits, similar to accessing the Curve Finance platform. That’s because Yearn Vaults does it for the user, relaying deposited funds to the other platform, in this case, Curve Finance.
Additionally, Yearn Finance deploys trading strategies to generate maximum returns. Depending on the type of staking pool represented by yTokens, these returns can come from LP rewards, trading fees, or interest rates.
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Additionally, these strategies work as batch trades instead of single sequential trades, which significantly reduces ETH gas fees. Each yToken will clearly describe the strategy used by the vault to maximize returns. A user (liquidity provider) could use them manually by just reading the description, but they might not be so profitable.
For more advanced users, they can access the labs. This Yearn Finance section lists vaults that use unconventional and experimental yield farming strategies.
The YFI token is an ERC-20 utility and governance token. YFI token holders can use their stacks to vote on new trading strategies for vaults or even change withdrawal fees and other aspects of the protocol.
YFI tokens are almost as rare as typical NFT collections. There is a maximum supply of 36,666 YFI tokens, all in circulation. Due to their scarcity and high demand, the price of YFI tokens reached an incredible high of $93,435 in May 2021, while its all-time low was in July 2020, at $739, when the platform started just gaining ground.
In addition to earning YFI tokens by depositing funds into Yearn Vaults, they are available on decentralized and centralized exchanges.
Risks associated with yield farming
Whether indirect through Yearn Finance or direct, yield farming can be risky. According to Chainalysis’ August report, up to $2 billion in crypto assets have been drained by smart contract exploits.
In addition to technical vulnerability resulting from poor coding practices and lack of auditing, the assets themselves could be risky. For example, algorithmic stablecoins are pegged to other cryptocurrencies, which makes them vulnerable to extreme market conditions.
TerraUSD (UST), DEI (DEI), Fantom USD (fUSD), and Neutrino (USDN) are just a few of the algorithmic stablecoins that have failed to hold their peg to the dollar. If this happens in liquidity pools, secured loans could be liquidated.
Moreover, due to interrelated trading strategies, one token depreciation could lead to another, triggering a cascade of contagion. Just look at the Yearn Finance TVL chart above to see that this has already happened after the collapse of Terra (LUNA) in May.
This article in the series is intended for general guidance and informational purposes only for beginners participating in cryptocurrencies and DeFi. The content of this article should not be construed as legal, business, investment or tax advice. You should consult your advisers for all legal, business, investment and tax implications and advice. The Defiant is not responsible for lost funds. Please use your best judgment and exercise due diligence before interacting with smart contracts.