What is real yield?
The #realyield narrative is a relative newcomer to the scene. In this article we break down what real yield means in DeFi and how some projects are harnessing this narrative to promote their products.
Real yield refers to DeFi opportunities that generate returns as a result of the product instead of as a result of farming or native token rewards.
As the bear market has continued, DeFi projects across the space have had to make hard choices on how to structure their tokenomics. With prices on DeFi protocol tokens down bad on the year, it no longer makes sense for many projects to incentivize their products with native tokens.
Where did the real yield narrative come from?
DeFi summer of 2020 was kicked off by projects like Sushi where yield came almost entirely from protocol token rewards. But as the bull market cycle of the past few years turned into a prolonged downturn in this year, projects have looked for other ways to incentivize usage.
[ Read our primer on Sushi’s Vampire Attack]
While token rewards can be good to bootstrap a protocol, over time they become a heavy expense and depress the prices from farmers constantly selling. Further, when token rewards decrease, many users also disappear and move on to other farming opportunities.
This means that token rewards are not only expensive for project treasuries but keep projects from finding true product-market-fit.
The prolonged macro bear market has also played a role. The “risk-free” rate set by US treasuries in traditional finance has spiked as high as 4%. This makes it ever-less attractive for capital to stay in DeFi with all of the associated risks and nuances.
So to attract liquidity and make it through the bear market, projects are turning to a time-honored tradition in business: actually making money.
What are some projects that promote real yield?
One of the earliest and understated progenitors of real yield in DeFi is Curve. With their original tokenomics mechanism, Curve set up a system where the longest-term believers in the protocol would make the most money. The veCRV token collects an admin fee on each swap (currently 50% of the swap fee). This is converted from pool tokens into Curve 3pool and distributed weekly to veCRV lockers. Since you need to lock veCRV for 4 years to maximize your amount, long-term stakeholders get the largest share of admin fees.
Sustainable fee yields drive this real yield narrative. A similar story of driving plays out in other prominent protocols.
GMX is often touted as one of the prime examples of real yield in DeFi. Liquidity providers in GMX’s GLP token hold a basket of stablecoins and crypto blue-chip. In turn this liquidity is made available through a virtual AMM to traders, allowing them zero-slippage trades with leverage.
GLP holders profit from several sources of revenue in this system. Along with the fees from trading, traders also pay high borrowing rates for taking leverage. Finally, GLP liquidity acts as the counterparty to all trades, so when traders lose, GLP holders win.
The result is that yields for GLP holders have been in the double digits, and GLP holders have outperformed their benchmark index of crypto assets.
Is this real yield sustainable?
There is a clear pattern in the real yield narrative. A well-designed product with smart tokenomics can generate good fee yield for token holders and liquidity providers. But it remains to be seen if this real yield is sustainable.
Since fees drive the return on investment, if fees go down, so does the yield. But the trend is encouraging. Even in a bear market, protocols like GMX have seen some of the highest volumes (and therefore fee yield) ever. As capital and users continue to move on chain, we can be hopeful that volume continues to increase. With the transparency and security offered by DeFi compared to centralized exchanges, we could also see more users move to use protocols like GMX.
What are other sources of real yield in DeFi?
Some standout protocols are delivering real yield with fees, some protocols are looking at other sources of sustainable returns.
While AMMs like Uniswap were pioneers in the space, there is a lot of data to suggest that being an LP in traditional AMMs is a losing game. Because you are always trading losing tokens for winning ones, much of the flow to Uniswap and other AMMs is arbitrage and toxic by nature. The result is that markouts on LP positions suggest LPs on WETH-USDC have lost millions of dollars in aggregate.
New versions of AMMs like SWAAP and Clipper move away from the constant-product market maker model.
Instead, these protocols look to capture different types of flow. Clipper targets retail flow with a small pool and low fees. Swaap allows trades against its pool at an oracle price, acting more like a traditional market maker and capturing a spread on trades.
New versions of AMMs like these push the real yield narrative and suggest reduced impermanent loss for LPs.
Porting over trades from traditional finance has also been a popular move to capture real yield. Basis trading is when a trader longs an asset in one venue and shorts it on another, capturing a yield spread between funding rates. Hedge funds in tradfi and crypto have regularly used this trade, and some protocols are replicating this in DeFi. By going long an asset on a decentralized perpetual exchange like Perp Protocol, while also shorting an asset on a lending market like Aave, an automated vault can capture a funding spread and generate real yield for depositors. There is no free lunch though as rebalances and changes in carry costs (the cost/gain of funding on your position) can eat into gains.
What is the future of real yield in DeFi?
If DeFi grows and these products continue to attract users, the search for yield will continue. Protocols that can attract real usage and have smart tokenomics will be able to capture the value and generate yield for their token holders as well as LPs. Similarly, borrowing yield sources from tradfi and porting the components to DeFi offers an attractive source of yield. Builders will continue to innovate in the crypto space, and as users turn away from the ponzinomics of token rewards, the real yield narrative will continue to have legs.