Where Does DeFi Yield Come From? | 10/12 Newsletter
You’ll gain a firm understanding of how DeFi yield sources differ from traditional finance
October 12, 2022
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Where Does DeFi Yield Come From?
October 12th Newsletter
This week’s newsletter is dedicated to helping you learn how DeFi works.
We’ve published our first whitepaper on this very subject: The Definitive Guide to Earning Yield on Digital Assets!
You’ll gain a firm understanding of:
- How DeFi yield sources differ from traditional finance
- What activities generate yield on digital assets
- Which protocols are making yield possible
- What risks are present and how to mitigate them
— The Index Coop team
DeFi vs. TradFi yield sources
In traditional markets, most yield comes from dividends on stocks or fixed rates on bonds and debt instruments. With the advent of decentralized finance (DeFi), however, new opportunities are available to earn yield in ways that are native to the blockchain. For new users in the DeFi space, a number of questions arise. In particular:
- What strategies are still available for earning yield?
- Where does yield come from?
- What are the risks of these strategies?
- How can I safely and sustainably earn yield on my cryptocurrency investments and holdings?
To learn more, download your copy of The Definitive Guide to Earning Yield on Digital Assets
How is yield generated in DeFi?
Yield earning opportunities in DeFi rely on smart contracts to automatically execute specific transactions when predetermined conditions are met. In traditional finance (TradFi), these types of transactions are executed by intermediaries, like banks.
There are three main categories of yield opportunity in DeFi:
- Staking
- Lending
- Providing liquidity
A look at DeFi’s yield-earning infrastructure
Earning yield is possible through active strategies using protocol mechanisms like staking, lending, and providing liquidity or through yield-earning leveraged products, which are more passive.
While protocols within one category provide similar strategies, they differ significantly in the backend, with each following entirely different complex algorithms.
The infrastructure that makes this possible includes:
- Stakeholders
- The Blockchain
- Lenders and borrowers
To learn more about each of these categories, check out: The Definitive Guide to Earning Yield on Digital Assets.
What are the risks?
As with all investments, and especially those in a period of rapid innovation, yield products carry a number of risk factors.
With financial middlemen replaced by programmable smart contracts and blockchain infrastructure, yield products and DeFi generally present risks that cannot be mitigated by reputational or regulatory collateral.
Though there are some similarities between TradFi and DeFi risks, the most prominent technical risks do not fit well into a traditional risk management framework.
These types of risk include:
- Systemic risk
- Volatility risk
- Regulatory risk
- Blockchain risk
- Smart contract risk
- Oracle risk
- Liquidity risk
What is the future of digital assets?
The future of yield-earning opportunities in DeFi is evolving in real time. Consumers, as well as protocols, are prioritizing investment in and development of more sustainable strategies.
This positions future yield earning to focus on fixed-rate rather than variable rate, newer strategies like market-neutral yield and options vaults, and a pivot toward yield sources not based in governance tokens. Short-lived, lucrative opportunities will be phased out in favor of lower-return strategies that can be relied upon in a variety of market conditions.
Download: The Definitive Guide to Earning Yield on Digital Assets
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