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Where Does DeFi Yield Come From? | 10/12 Newsletter
Where Does DeFi Yield Come From? | 10/12 Newsletter
You’ll gain a firm understanding of how DeFi yield sources differ from traditional finance
10/12/2022
Index Coop
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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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FAQs
Index Coop yield tokens simplify earning yield in DeFi by automating complex strategies and diversifying across protocols. They are user-friendly and cost-efficient, appealing to both new and seasoned DeFi users.
Leverage tokens automate a leveraged position by utilizing onchain money markets like Aave or Morpho to borrow funds, amplifying a user's exposure to an asset without requiring manual management. The token's smart contracts autonomously handle the borrowing, lending, and rebalancing of assets, maintaining a consistent leverage ratio despite market fluctuations. This automation eliminates the complexities of collateral management and liquidation risks, while also charging low, transparent fees that avoid expensive funding rates often charged by perps.
Index Coop is a decentralized autonomous organization (DAO) that specializes in creating and maintaining onchain structured products. Index Coop aims to democratize access to the crypto market, empowering everyone to participate in the growing digital asset ecosystem with ease.
No, yield automatically compounds and accrues to the token price. The value of the tokens you hold in your wallet will simply go up over time without the need to claim or compound rewards.
Index Coop products protect you from liquidation with automated risk management that rebalances assets to maintain a target leverage ratio that avoids liquidation.
INDEX is the ERC-20 governance token on Ethereum for Index Coop. INDEX empowers its holders to participate in decision-making processes that shape the future of Index Coop.
Yes, all Index Coop products are instantly redeemable for their underlying value at all times.
Yes, all Index Coop smart contracts have been audited by leading independent security firms such as OpenZeppelin, ABDK, Isosiro, & more. There is also an active bug bounty program through ImmuneFi. Audit information is published in the docs here.
Streaming fees (an annual fee paid continuously block-by-block), mint and redeem fees (only on leverage tokens), and borrow costs (interest paid to borrow funds from onchain markets when using leverage).