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DeFi Friday - Stablecoin Farming 101
Is earning yield on stablecoins worth it?
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Current State of DeFi
Total Value Locked (TVL) across all of DeFi: $47.29 Billion (+5.11%)
Chains with notable TVL growth pas 7 days:
Chains with notable TVL decline past 7 days:
Stablecoin Farming 101
Today we’re going to give an overview of Stablecoin Farming: the act of using DeFi to earn a yield on stablecoins. A stablecoin is a token that is pegged to the value of something—usually (but not always) that means the US dollar. In most of the examples we talk about today, we’ll be referencing US dollar-pegged stablecoins. But there are also tokens that are pegged to other things such as the price of gold, inflation rates, etc.
Throughout this post, we’ll cover common strategies for earning stablecoin yield, associated risk, and some general pointers to get you started. Let’s dive in!
Risks of Stablecoin Farming
It’s most important that we start with the risks involved so that everyone understands what they’re getting into before they go searching for high yields.
1. Stablecoins aren’t always stable
A recent example you’re likely familiar with is UST, Terra’s failed algorithmic stablecoin. At its peak, right before it depegged, UST had a market cap of $18.7 billion. Last May, UST went from pegged to $1 to a few cents in a matter of days.
However, UST is not the only failed stablecoin. A quick look at CoinGecko’s stablecoin category will give you a sense of how unstable some of the smaller market cap tokens can actually be.
How can you have faith that a stablecoin will remain pegged?
You should always do your own research on any stablecoin that you plan on holding or gaining exposure to in some way. Different stablecoins use different methods to keep their value pegged. There are a ton of different methods for keeping a stablecoin pegged.
Some are fully collateralized by crypto-assets
Some are fully collateralized by real-world assets (bonds/treasuries/etc)
Some are fully collateralized by a mix of both crypto-assets+real-world assets
Some are partially collateralized and partially algorithmic
Some are fully algorithmic
Some are “soft” pegged with the use of interest rates
You should know how your stablecoin works, the risks associated with that model, and where there is the most liquidity to get into and out of the stablecoin in case you need to. The best way to do this is to read whitepapers, join discords to ask the devs questions, and refer to Defillama or GeckoTerminal to look at liquidity.
The 10 largest stablecoins by Market Cap are:
Here are some quick highlights of some of the tokens on this list:
USDT (managed by Tether), USDC (managed by Circle), BUSD (managed by Binance) are all fiat-backed stablecoins. This means that they maintain financial reserves in fiat currency (or assets denominated in USD) held by regulated institutions. Some of this backing is in cash, some in short-duration treasuries, bonds, etc. Each of these stablecoins has slightly different strategies and approaches to their reserves. If you are going to build up exposure to any one of them, you should do your own research and make sure you understand the reserve management process.
DAI is a bit unique from the more traditional fiat-backed and centralized stablecoins. It is a decentralized product of Maker, a DeFi protocol. DAI is able to maintain a reserve because of the locking of crypto assets (like USDC and ETH) in its smart contracts.
Frax is also unique. It is a stablecoin that is a mix of collateralized and algorithmic. As of the time of writing, the FRAX stablecoin is ~92% fully collateralized (mostly USDC), and 8% algorithmic. These percentages fluctuate over time, based on the market, and the mechanism is a little too advanced for this intro guide, but we encourage anyone who is interested to read through the Frax documentation, read this great overview from Messari and also take a look at the dashboards on the Frax protocol.
A final callout to Tether Gold - an example of a stablecoin that maintains a peg to something other than 1 USD. One XAUT is equal to one troy fine ounce of gold on a London Good Delivery gold bar. While the most popular and liquid stablecoins are all pegged to the US Dollar, there are dozens of stablecoins pegged to other currencies, real-world assets, and even inflation (see FPI from Frax)
2. DeFi is vulnerable to exploits
In 2022, over $3 billion was lost in smart contract exploits across DeFi. Whenever you use DeFi and interact with a protocol, there’s always a chance that it has smart contract code that’s exploitable, or it could be vulnerable to being rugged by the creator of the protocol.
Here is a small sampling of the methods used to exploit DeFi protocols last year: flash loan pools, arbitrage bots, router exploits, private keys compromised, price oracle attacks, access control exploits, reentrancy, drain contracts, and many many more.
Is there a way to avoid hacks in DeFi?
Even the best DeFi farmers can still get caught and lose funds in exploited protocols. To some extent, it’s just a part of the game for now. The best things you can do to protect yourself from exploits are:
Look at and read the smart contract code if you’re technical and know what to look for.
Use protocols that have some audits from reputable auditing firms (I like to see a minimum of two completed audits).
Look at protocols with at least $X TVL. ($X will be different depending on each person and their risk tolerance.) This metric gives you a good sense of how risky other players in the market feel the protocol is. It doesn’t necessarily mean the protocol is safe, but “the market” has deemed it safe. Keep in mind, there was a lot of value locked in UST before it blew up.
This one may be controversial: stay away from autocompounders. Autcompounders introduce another layer of potential smart contract risk and are some of the most commonly exploited protocols. All they do is compound your rewards for you. You can easily avoid this risk by just compounding yourself manually.
And finally, don’t put too much of your capital into any one protocol. You could check off all of the above and still get exploited. When you lose funds, it feels a lot better to lose 1-3% than 20-30% of your capital.
3. Slippage and Transaction Costs
This may or may not technically be considered a risk because it’s usually self-inflicted, but I wanted to include it because it’s something that you should be aware of if you decide to explore the world of stablecoin yields.
Every time you exchange one stablecoin for another, you have a cost.
Exchange rate: when you’re exchanging $1,000 USDC for USDT, it won’t always be exactly 1:1. You may only get $998 USDT. The total “cost” of the exchange rate increases at higher volumes. Going from $1,000 USDC to $998 USDT might only be $2 but moving $10,000 to 9,980 USDT is $20.
Slippage: This is the price difference between when you submit a transaction and when a transaction is confirmed on the blockchain. The slippage you experience is directly correlated to the liquidity, volume, and volatility of the pool that you’re using to swap. Pools with high volume, low volatility, and lots of liquidity will experience the least slippage. If you’re swapping stablecoins, I recommend using Curve (protocol) because it is designed specifically to be highly efficient at stableswaps. If you want to learn more about Curve and how their math for liquidity pools is different than a basic LP pool, you can read more about it here. Or you can also use a dex aggregator that will look at all of the possible ways to swap between two tokens and find the best route for you.
Gas fees: You have to pay these with every transaction. You’re also paying gas when you claim farm rewards and if you swap those reward tokens into another asset.
I bring all of these up because stablecoin yields are low across the board right now. If you’re not careful and you’re claiming rewards too frequently or swapping from one stablecoin to another too often, you’re likely not actually earning that much if you take into account all of the expenses you’re incurring.
4. Centralization Risks
Different stablecoins have varying levels of decentralization.
USDC, the 2nd biggest stablecoin, infamously blacklisted all ETH addresses owned by Tornado Cash listed by the US Treasury Department’s sanction.
The USDC “Blacklist Policy” states that when an address is “blacklisted” it can “no longer receive USDC and all of the USDC controlled by that address is blocked and cannot be transferred on-chain.”
Currently, there are 151 blacklisted addresses by USDC, of which those wallets hold $7.3 million USDC.
Depending on your risk appetite, and your values surrounding decentralization, you’ll need to look at each stablecoin and decide if it matches your criteria.
Finding Yield on Stablecoins
If you made it to this point and you are still curious about earning yield on your stables, good for you!
There are a few different types of protocols that offer stablecoin yield. The 3 most common are:
Decentralized exchange (DEX) liquidity pools (LPs) that pair two (or more) stablecoins together
Bridges or bridging solutions
The lending side of Borrowing and Lending protocols
It’s important to understand where this magical “yield” actually comes from. Most of the yield you’ll find in DeFi will fall into one or multiple of the following categories
Swapping and/or other earned fees: When you enter a Liquidity Provider (LP) position of 50% USDC and 50% DAI on a decentralized exchange (DEX), you will earn a portion of the fees that traders pay in exchange for being able to use your liquidity to swap into and out of those two stablecoins.
Lending Rates: When you deposit your USDC on Aave (or any other borrowing/lending protocol), other individuals can take that USDC out in the form of a loan and pay you a variable (sometimes a fixed) interest rate.
Share of protocol revenue/profits: A good example of this is the Gains DAI vault. On Gains, you can deposit DAI into a vault that acts as a counterparty to leverage trades on the Gains trading platform. When traders win, their winnings come out of the vault, when traders lose, their losses are sent to the vault. As a reward for being the counterparty, the vault receives a portion of trading fees.
Incentivized Liquidity: Incentivized liquidity can be paired with one of the above forms of yield. This is when a DeFi protocol will pay you in their native token as an incentive to bring liquidity and usage to their platform. Radiant, a borrowing and lending protocol on Arbitrum, is a good example of this.
On Radiant you can deposit USDC and earn 2.17% paid in USDC for lending your USDC but you’ll also earn an additional 2.02% in RDNT (Radiant’s native token) as an extra incentive.
When looking for stablecoin yield it’s usually best to approach it in steps:
Determine what stablecoins you are comfortable holding
Determine what level-of-risk protocol you’re comfortable with
Look for opportunities that match both of those criteria
I would never recommend doing it in reverse order because you will find yourself making compromises on what coins you hold based on yield, and that’s never a good justification.
Let’s say you are comfortable holding USDC, USDT, DAI, and MAI.
DefiLlama has a helpful tool where you can look at yield opportunities, filter by token, and choose the “stablecoin” attribute.
Here is a search for those four stablecoins.
If we were to start by just looking for the highest yield, we sort the list to display the highest APY first, and we can see that we could earn 195% on an AUSDO-USDT.E pool.
This is where you have to be really careful. AUSDO and AUSD are both failed stablecoins, and all of the above pools have VERY low TVL. Meaning that you could potentially be left as one of the few in the pool holding a bunch of worthless assets.
Let’s say you want to take a look at “medium risk” opportunities. You can choose to only look at pools with $1+ million in TVL. This brings up some more interesting opportunities but you still have to be cautious.
DUSD, for example, is an incredibly small stablecoin that is almost never pegged to $1.
You’ll also want to make sure that if you enter a pool with a small or “fringe” stablecoin you’re not becoming exit liquidity for other people to trade out of their fringe stablecoins into something else.
Before entering a pool, you’ll want to look at that pool’s contract address and make sure there are roughly even amounts of each stablecoin left in the pool.
Take a look at this example from Beethoven (Fantom balancer fork).
This stablecoin pool is comprised of alUSD (a depegged stablecoin) and other stablecoin assets. The pool has $33K in TVL, but $29,251 of it is alUSD. This is because a lot more people have used this pool to exit alUSD than to go the other direction.
If you were to enter this pool with more liquidity, you’d just be making it easier for other people to get out of their alUSD positions.
If the DEX you’re using doesn’t display the breakdown of the pool, you can always grab the pool contract address and bring it to Nansen.
By now you’re probably thinking, “Dang, there sure are a lot of things that could go wrong in stablecoin farming. Is it even worth it?”
That’s the correct question to be asking!
The yield you can earn on “safe” stablecoin farms has been severely depressed in this market environment.
As of today, the average rates you can get in “medium” risk stablecoin opportunities are ~5-7%, while the average rate you can get in “low” risk opportunities are ~2-3%.
A few examples (This is NFA, DYOR, all of that. Everyone has a different risk level. Don’t listen to a stranger on the internet, etc.):
I’m going to leave out UniV3 Concentrated Liquidity positions. You can earn yield on stablecoins this way but it’s very risky and I would not recommend it for beginners.
USDC-DAI-MAI-USDT on Balancer (Polygon) paying 9.19% APR (8.99% of which is in BAL rewards)
USDC-USDT on Velodrome (Optimism) paying 7.53% APR (all of which is in VELO rewards)
MAI-USDC on Aura (ETH Mainnet) 6.80% APR (mix of AURA and BAL rewards)
USDC on Stargate (polygon) 6.01% APR (all of which paid out in STG rewards)
USDT on Stargate (Arbitrum) 5.46% (all of which paid out in STG rewards)
I would really only consider Aave and Curve as the lowest-risk protocols you can use to earn stablecoin yield. All of their yield opportunities are from 0.01-2.0% APR.
Using Leverage/Looping Methods:
On certain borrowing and lending protocols, there are times when you can actually be paid to borrow thanks to incentive programs.
Let’s return to the Radiant example. You can see that the RDNT rewards you earn on the amounts that you borrow are actually higher than what you have to pay to borrow those assets.
This is also possible on Geist Finance, a borrowing/lending protocol on Fantom.
On Radiant, you could set up the following strategy.
Deposit DAI as collateral, borrow DAI (80% of what you deposited to be safe, DAI has an 85% collateralization ratio).
Take the borrowed DAI and deposit it as collateral, and borrow another 80% of that in DAI.
Continue this loop 12 times and you’ll have the following set up.
You would effectively be earning a 61% APR on your initial $1,000 deposit. Now keep in mind, there are some stipulations around the RDNT tokens that you’ll earn in this strategy. It will accrue as locked RDNT and you’ll have to enter a 28-day vesting period in order to get a liquid version that you could sell off into other tokens. In other words, your realized yield will likely look very different than the projected 61%.
Level 2 of this strategy would be to optimize the yield you’re earning by borrowing and lending different stablecoins. Instead of just depositing and borrowing DAI, maybe you choose to deposit DAI but borrow USDC since it has a more favorable lending rate, then swap that USDC for DAI and continue the looping process: deposit DAI, borrow USDC, swap USDC for DAI, etc.
If you choose to engage in these strategies, keep in mind that they’re inherently risky and you’ll need to be somewhat active in managing these positions.
The rates and incentivized rates are variable and volatile. These strategies can go from profitable to unprofitable fairly quickly.
Whenever you start mixing stablecoins (depositing USDC, borrowing DAI) you introduce the risk of liquidation. If the prices of either of the assets fluctuate, depending on how leveraged you are, you may lose some of your initial deposit.
Managed and Automated Vault Strategies:
There are a handful of DeFi protocols that are building vaults where users can deposit a stablecoin and a smart contract will deploy those stablecoins into some of the mentioned strategies. But most of these vaults are new and still somewhat rudimentary.
Yearn is one of the most well-known examples. Just like with auto-compounders, I generally don’t think that the added smart contract risk of these platforms is worth it.
Other Helpful Tools:
Nanoly is a great tool for sourcing yield opportunities across different chains and tokens.
Stable.fish is similar to Nanoly with a focus exclusively on stablecoins.
Exponential will give you an estimated “risk” score along with the yield of the stablecoin opportunity.
Serenity Fund is a great Twitter account to follow if you want to stay engaged in the stablecoin farming ecosystem and hear about new opportunities.
Conclusion: Is stablecoin farming worth it?
As with all complicated topics, the answer is: it depends. In the current market environment, it’s hard to make the argument that stablecoin farming is the best risk/reward use of your money.
If you can currently earn 3.8%-4.8% APR on your real USD dollars at an FDIC-insured bank or by buying treasuries, it doesn’t really make sense to chase opportunities for 6-8% APR on stablecoins where you have to calculate the likelihood of a depeg event, smart contract bugs/exploits, not enough liquidity to exit position, gas fees, etc.
However, there may be one valid argument for stablecoin farming today: If you’re farming to gain exposure to a reward token that you think will be worth much more in the future.
Let’s say that you really like Stargate and want to increase your exposure to their STG token. You could buy STG or you could scale into your position “risk-free” by entering a pool on Stargate with stablecoins and start earning STG rewards.
The APR you see listed on those pools today is partially dependent on the price of STG.
You could spend a year yielding STG rewards at 6% APR but if after a year, the price of the STG token raises 5x, the “true yield” that you earned on your farming position over the course of the year would be much higher than the 6% displayed.
So, the choice is really up to you!
Right now, stablecoin farming probably isn’t worth it in most instances. But if you see a pool that will help you grow exposure to a token you think will increase in price later, you’ll need to do the mental math to determine if that position is worth the risks associated with it.
Disclaimer: This is DeFi, everything is risky. Smart contract risk is real and you should do your own research before interacting with these protocols to determine if the risk matches your personal appetite. Finally, some of these protocols have their own token, and inclusion on this list doesn’t mean that we have an opinion on their token.
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