Where does the high income of DeFi mining come from? sustainable?
Original title: "Analysis | Where does the high income of DeFi mining come from?" sustainable? "
Original author: Julian Koh, founder of Ribbon Finance, a DeFi protocol that provides structured productsOriginal compilation: Perry Wang, Lianwen< /em>
One of the main narratives of decentralized finance DeFi is that, given the high yield Will have to move their fiat to the DeFi space. From an empirical point of view, this is true-today, the loan interest rate of stablecoins on the Compound protocol is more than 10% APY, and there are still many mining opportunities in the DeFi field with APY of 50% to 200%. You know, in the real world, most banks offer customers no more than 1% interest rate on deposits.
But when the average person first hears these earnings figures, most are wary rather than confident. “This has to be a scam!” Yields have to reflect hidden risks that we crypto fans don’t take into account. This is a reasonable assumption - smart contract risk is difficult to quantify, so loan providers may demand high interest rates from borrowers to compensate for this risk.
Historical loan interest rate of USDC in the Compound agreement
Looking at the historical loan interest rate of USDC in the Compound agreement, you can see that the loan interest rate has increased over the years From -1% all the way to over 10%. And the smart contract risk in this agreement has not changed in any real way, which shows that high interest rates may be driven more by demand than supply.
Now that we have figured it out, why are borrowers willing to pay such high interest rates to borrow cryptoassets?
Going a little deeper, lending assets is just one of the ways people can earn income. To really understand where the benefits come from, we first need to think hard about how money grows, and why it's okay to invest money in something and get paid. In my view, returns come from four categories: borrowing demand, risk exchange, service provision, and equity growth.
This article will analyze in detail one by one to really understand the benefits of DeFi.
Natural need to borrow
The most obvious source of benefit is the naturally occurring need to borrow. Businesses need to borrow assets to buy capital goods, banks need short-term loans to fund their activities (the repo market), and individuals may need loans to pay for college. Because of this natural need to borrow, a market of borrowers and lenders begins to form, and these loans are priced—one person's need to borrow is another person's benefit.
Looking ahead, precisely because this natural need to borrow has remained at a very basic level, it is almost never likely that this yield will dry up.
Another reason why there is a natural need to borrow is that people crave leverage. As some people say: "Leverage is a ****".
Investors who are extremely bullish on assets may want to borrow cash to buy more assets, especially if they expect assets to grow faster than borrowed The interest rate paid. This is very clear in the DeFi space. Platforms like dYdX and Alpha Homora have some of the highest lending rates of any DeFi protocol because these platforms have created very simple ways for borrowers to use these borrowed assets in leveraged positions.
To create high-yield products, you need to stimulate a lot of borrowing demand, and investment leverage is one of the best ways to stimulate borrowing in the current market environment.
Risk exchange
Another source of income is through risk exchange, which is generated with borrowing demand intersect. The simplest example here is insurance.
If Alice wants a kind of financial protection, if she is involved in an accident, she can get compensation, so she is willing to pay Bob some cost. Essentially, Alice and Bob are exchanging risk with each other, and Bob receives some benefit for taking that risk.
Another prominent example of risk exchange is through options contracts. Option buyers are willing to pay a premium to protect themselves against wild swings in the asset's price, while option sellers get some gain for being on the other side of the deal.
One of the new ways to exchange risk in the DeFi space is through risk grading (tranching). Protocols such as Saffron Finance take cash flow and divide it into different parts - risk level Junior (ie the most risky) part gets a larger share of the return from the cash flow, but has to bear the loss of cash flow risk, while the senior Senior part gets lower cash income, but its investment in cash flow is guaranteed.
Essentially, Junior and Senior level assets are swapping risk when they boil down to income opportunities with different risks.
These risk exchange contracts are a huge market in traditional finance due to the fact that different individuals/institutions inherently have different risk profiles, in this Driven by , there is always an inherent need for risk exchange.
So, in the long run, I guess this will also become one of the main sources of DeFi revenue.
Service provision
A less intuitive source of revenue is: you can use asset provision Services to earn money. For example, money changers can charge fees because they use their own assets to provide their services. The reason for gaining benefits in the context of a money changer is to provide the convenience of exchanging between two currencies.
Another example is an ATM - a machine with cash in it that allows customers to instantly withdraw funds from their bank account to buy goods and pay for services. An ATM is a service that customers are willing to pay for.
In the DeFi context, providing liquidity to automated market makers AMMs can fall into this category of earning income. By providing assets to AMM, it is possible to efficiently provide services to users who want to exchange assets. Taking the Uniswap protocol as an example, the liquidity provider LP charges 0.3% compensation for each transaction.
As long as we expect the demand for these services to persist over time, we can also expect their respective benefits to persist.
However, providing such services has its own risks, specifically providing assets to AMMs may suffer "impermanent loss". In the long run, providing liquidity to AMM assets will be a positive earning move if the cost of hedging these risks is sufficiently lower than the gain from providing the service.
Equity Growth
Another source of "income" comes from the value of equity growth. If you had lent money to Uber at the seed stage in exchange for an equity stake in the business, the return on that investment would have been staggering, primarily driven by growth in the value of the equity.
Most of the high returns in DeFi today are driven by the growth of equity (encrypted assets). For example, when you mine on Compound, you are essentially lending money to the protocol and getting free equity (free COMP tokens). So you get the base yield on the loan asset (from the natural borrowing demand) and also earn the "gain" of the appreciation of the COMP token.
Because DeFi assets are in a hypergrowth phase right now, most of the crazy yield numbers you're seeing come from equity growth.
Many DeFi protocols see this avenue as a short-term way to attract users to their protocol. They hope to win a large number of users by offering staking for free. Therefore, the current main strategy of asset owners is "income farming", that is, to get these equity incentives for free, and pray for the value of these assets to rise, so that their overall income will soar.
It is unclear whether this source of income will continue in the long term. Once the protocol realizes that the equity incentives handed out to acquire users are not worth the effort, they may turn off these incentives.
The main strategy for DeFi to earn income in the future is likely to be driven by one of the other three factors, rather than equity growth.
Conclusion
As the DeFi ecosystem matures and develops along the S-curve, We may see yields drop from the ridiculous 1000% APY to more "normal" levels.
Over time, equity incentives may decrease and the asset will move out of its high growth phase. In the future, I expect to see more sophisticated product design in the risk swap space as people design more complex financial products that increase yield.
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