By Honson Tran
In the world of traditional finance, investment banks and financial institutions often have market making roles in the stock market. Their job in the markets is to provide liquidity, ensuring there is enough volume of trades so that your buys and sells can be fulfilled within seconds. In return, market makers profit off of the slight differences between the buy and sell price whenever a transaction occurs. Without them, investors would not be able to bolster or unwind their positions. A prime example of our need for market makers is back in the day when bartering was used. Since there was no medium of exchange, and no market maker to ensure the market was healthy, it was rather difficult to determine the value of commodities being exchanged. For the average person a stream of revenue that comes from being a market maker is impossible in the traditional financial world, but with the power of decentralized finance, it can be done.
Decentralized Finance (DeFi) has sent shockwaves across traditional finance, challenging high entry barriers and opaque processes. According to DefiLlama, the Total Value Locked (TVL), also known as the overall value of assets deposited into DeFi protocols, into the DeFi sector surpassed 200 billion in 2021. In DeFi, TVL is a very important metric of how much money is held in protocols to accrue interest and earn incentives. Inside these DeFi protocols, there are financial services that the average person could provide, often with higher APRs than traditional finance. For instance, one attractive service you can partake in is called yield farming. Similar to market makers, yield farming is the act of profiting by providing liquidity in a decentralized exchange (DEX). You receive a percentage of the transaction fees that the DEX generates based on the liquidity you have provided.
How Do I Get Involved in Yield Farming?
In yield farming, users place their liquidity into an Automated Market Maker (AMM). AMMs are meant to be the market makers in the decentralized world, with the important role of automating the intermediary institutions that we often see in traditional finance. The fundamental steps to get into yield farming are simple. Users will buy two different currencies with amounts that equal each other in US dollar value (1:1 $USD ratio), and then choose a DEX to put this liquidity into a liquidity pool. For instance, if Bitcoin was $30,000, and Ethereum was $2000, for every Bitcoin that you want to provide liquidity for in the BTC-ETH pool, you will supply 15 ETH for every Bitcoin. From here, every time that pair is traded on the exchange, you will accrue transaction fee profits, allowing you to sit back and enjoy the passive income stream! The rewards you generate will often be in the form of the DEX’s token. For instance, those who utilize the UniSwap DEX will receive Uniswap tokens (UNI). These tokens can then be liquidated back to USD, or saved up to be used as voting power if you’re interested in voting on which direction the protocol moves towards.
Wait, what’s the catch?
With yield farming, it’s not all “free” money. Oftentimes, your APR in yield farming is dependent on how much liquidity is in that pool. For instance, a pool that is supplying liquidity for Ethereum and Bitcoin exchanges is more common than Ethereum and some other random token. APRs are often higher in liquidity pools that lack liquidity, primarily because you will have a bigger percentage of the pool, thus a majority percentage of the transaction fees will go to you. Yield farming is highly effective when providing liquidity for a pair’s price action that is highly correlated to each other. Additionally, well established cryptocurrencies can reduce additional risks, one of which is impermanent loss.
Impermanent loss occurs when the price of a token increases or decreases, which can affect the 1:1 ratio as aforementioned. This is highly detrimental in riskier tokens that aren’t as stable. For instance, let’s say you provided 2 different tokens, each valued at $100, for a total of $200. You then place this liquidity into a pool, but the price of token A skyrockets to $400, and the price of token B stays at $100. Due to the change in price, the AMM will readjust this 1;1 ratio in the pool to show that there are more B tokens than there are A tokens. When a fellow yield farmer wants to remove their liquidity from the pool, they will instead receive 0.5 A tokens, and 200 B tokens. Thus, the farmer experienced impermanent loss because had they just held the tokens, they would have gained more in value. Using an impermanent loss calculator, you can calculate the loss of potential profits to be 20% had the farmer just held.
Yield Farming Troubles & COMB’s Solution
Although the steps to get into yield farming seem easy enough, there are countless tokens to farm. How does a user know which token should be farmed? Which one is more promising than the other? Yield farming involves many different platforms and steps to move around funds at times, and manually compounding is even a lot more bothersome if you want something that is “set and forget”. With COMB, a user can easily diversify into blue chip farming tokens from a single token. COMB is a DeFi platform that seeks to aggregate a huge variety of DeFi services into one singular platform, including yield farming. By purchasing COMB and committing to locking it for a set amount of time, you will accrue rewards from a vast majority of DEXs to diversify your portfolio with the same amount of money. In addition, users can utilize COMB’s autocompounders which are designed to harvest these rewards, and reinsert them back into liquidity pools to gain more rewards. Whether you are a seasoned farmer, or someone starting off, using COMB as a platform to diversify your yield farming initiatives and to increase your interest rate through auto compounding is a great way to make money work harder for you.
Honson is a 25 year old computer scientist focused on technologies that have the potential to augment the way we live our lives today. By day, Honson works at an AI startup focused on creating powerful tools to accelerate the adoption and performance of AI on the edge. By night, he heads operations at COMB. Honson first gained interest into blockchain after receiving a scholarship during his university days. Instead of using it to pay his school loans back, he took a chance at mining Ethereum when it was as low as $300. After looking deeper into blockchain technologies, Honson soon found himself in disruptive topics in blockchain, such as decentralized finance.