Origins of Yield?Farming
Yield farming emerged as an effect to the issuance of DeFi protocol governance tokens, which began earlier this year.
Yield farming consists of locking digital assets in a DeFI protocol to generate rewards (yield) in the form of governance tokens.
Users can then lend and borrow against the token, lend and borrow again, etc. Similar to using leverage to arbitrage, there is a risk of losses insofar as the Annual Percentage Yield (APY) rate fluctuates wildly. At the same time, it is possible to generate obscene returns, in some cases essentially doubling or more the initial capital.
The Weakness of Current?DeFI
The extremely high APY percentages available on some DeFi protocols have overshadowed a core underlying issue.
Right now, earning through yield farming is overly dependent on DeFi protocol governance tokens remaining highly valued, which is not at all guaranteed.
This is because the value of these tokens is based on exchange value, rather than value linked to the actual volume of loans being created or token swaps being facilitated by the protocol. Yield-farming operations that are profitable one day can quickly become money losers as governance tokens fluctuate in price.
Making money using yield farming is highly dependent on governance tokens remaining at high valuations but most of the popular DeFi Protocols will explicitly state their token has no value.
“….we have released YFI, a completely valueless 0 supply token. We reiterate, it has 0 financial value. ”
— Andre Cronje, Founder, Yearn.Finance
“Yield farming is nothing but giving users of a protocol a little bit of ownership of that protocol. That has value insofar as people believe that protocol will be valuable in the future.”
— Fernando Martinelli, CEO, Balancer
The only reason to hold or keep using these tokens is because you think other people want them. Aside from some basic voting rights they have no utility. they are a purely a speculative asset. This detached set up will lead to people abandoning that solution for others whose governance tokens are still able to retain adequate value.
As competition grows, however, successful high-yield strategies will become more complicated and risky.
This will add pressure on this first generation of “0 financial value” governance tokens.
Q: What is the main weakness of yield farming on current DeFi platforms?
A: Yield farming on DeFi platforms involves locking digital assets to generate rewards in the form of governance tokens that have no inherent value.
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