For many crypto veterans, the recent mania surrounding yield farming has been reminiscent of old times. Transaction fees are through the roof, tokens are skyrocketing to irrational valuations and now, like clockwork, people are starting to exploit protocols and users amid all the noise.
This is what 2017 felt like, but we’re only a week into it. It’s crazy to think that while we’ve spent the past three years building and nurturing the ecosystem into maturity, all it takes is one spark to blow it up.
Even though it’s been short lived so far, we’ve cultivated some valuable knowledge in the early days of Ethereum’s newest craze.
These are the lessons we’ve learned a week into the Yield Farming Mania.
We Need Scaling
The inflow of new interest and new capital into the Ethereum ecosystem has forced transaction fees to new levels not seen since the ICO bubble in 2017/18 . Ethereum is nearing all-time highs on transactional metrics as transaction count is hovering around 1M processed per day while the average fee sits at $0.78.
And while many are willing to pay these higher fees to capitalize on the attractive yields or to speculate on DeFi tokens, other Ethereum use cases are being kicked to the curb. Gaming, DAOs, and the other emerging use cases of Ethereum are, in many instances, too expensive to even bother using the network.
As outlined by our friend DeFi Dude, It’s nearly impossible to summon a DAO without paying astronomical fees or having some clever engineering to work around the congestion.
While normal ETH and ERC20 transactions are not too bad, anyone who wants to leverage Ethereum’s capabilities for complex, decentralized computation is suffering.
At the end of the day, yes, this is a great sign that there’s demand for Ethereum as a global settlement layer. But it seems that we’ve made minimal progress in actually implementing significant scaling solutions over the past few years since we last came across this issue – instead opting to increase the block gas limit (block size) and bloating the network.
Luckily, we know that Ethereum 2.0 is on the horizon and will likely kick-off this year with the launch of Phase 0. The downside to that news is that the full network upgrade is still years away from being implemented on mainnet. So we shouldn’t bank on ETH 2 solving the scalability problem anytime soon.
Fortunately, we’ve seen a plethora of Layer 2 scaling solutions come into fruition in recent months. But it’s not all the way there yet. There are still some outstanding issues surrounding liquidity and composability with L2 solutions that add a significant amount of friction. From my limited perspective of L2 solutions, it’s not impossible to solve. It’ll just take some time. That said, we can hope that Ethereum’s dedicated developer community will eventually find a workable solution in the coming future.
Incentives Are Easy to Game, Hard to Design
The past month featured the launch of two prominent yield farming opportunities – BAL and COMP. Both of these launches were highly anticipated, and even more successful.
Both DeFi protocols quickly experienced issues regarding incentive design within days (not weeks) of the protocol launching its “liquidity mining” program.
Balancer is the most notable (and recent) victim. Last night, the protocol saw a massive inflow of liquidity in a fake token led by a relatively prominent CEX, FTX Trading.
Balancer uses CoinGecko price feeds to calculate liquidity in pools. Big players like FTX have the power to arbitrarily create an asset and a price feed on CoinGecko, allowing them to deposit $100M in liquidity in “USDT BEAR” and “USD HEDGE” tokens and soaking up over 50% of the weekly BAL distribution.
Updated with response from FTX CEO:
For Compound, the incentive issues largely surround “crop rotations” and how users are flooding in and out of different markets in order to maximize their COMP earnings. The most recent victim of crop rotations – BAT – is offering insanely high APYs on both sides of the market (lending and borrowing). This is leading a lot of users to supply BAT as collateral (lend) and using its borrowing power on other assets in the protocol. The unexpected consequences of yield mining have led Compound to have concerning levels of liquidation risks as over $200M of the protocol’s assets are backed by a highly nascent, volatile, and illiquid asset.
Despite only being 1 week into the yield farming mania, there are already issues coming to light. For many, it’s bringing back memories (good and bad) from the past crypto bubbles. It’s also a glimpse of what’s to come.
Yield farming is only going to get more complex, providing more attractive returns for farmers willing to get their hands dirty. We’re already seeing hints of this with the Curve BTC pool which incentivizes liquidity providers with multi-asset rewards in SNX, REN, CRV, and BAL.
We’re only scratching the surface for the potential of composable yield farming. This is almost certainly the beginning of a period of speculative mania – one that is already driving crypto assets to highs not seen before.
As we’re already starting to see, we’ll have our issues along the way. Dan Elitzer stated it really well in a piece earlier this week:
There are likely to be hacks, exit scams, short-term asset price manipulation to cause liquidation cascades, and a whole host of other ways in which people (and likely some professional funds) lose a lot of money. With the natural interconnectedness of many of these protocols plus the massive financial incentives of liquidity mining to stack them as deeply as possible, it’s possible that the whole thing comes crashing down.
Even if that happens, it will be rebuilt. The promise of truly open, permissionless financial services is too great to die.Dan Elitzer
But my favorite part of this whole thing? We’re just on the cusp of the most lucrative yield farming opportunity that will change Ethereum forever (literally):