Your bank offers 0.2% APY but BlockFi offers 8%. Are high yields in crypto for real?

The answer is yes AND no.

Here’s my review of 6 types of yields in crypto, ranked from most Ponzi 🤡 🤡 🤡 🤡 🤡 to most durable 🏰 🏰 🏰🏰 🏰.

(Note: A Ponzi simply means the price of X depends on more people buying X, but without creating a meaningful network effect of intrinsic value. I have nothing against Ponzi. You can make money in them as long as you’re not the last fool. A lot of things in life work that way.)

TYPE 1: Staking a token with 100% APY

100% percent of zero is zero.

There are deFi projects hoping to get adoption by offering high yields. The APY is counted in the native token. Since the token is thinly traded, price can be easily manipulated and doesn’t mean much.

These tokens also tend to have a high inflation rate— more are circulated every year, so you may not even get a higher share of the total issuance even after the astronomical APY.

(100% APY – 50% Inflation) x 1% Chance of project survival = 0.5%, but it’s denominated in native token

You might as well give money to your bank.

Ponzi score: 🤡 🤡 🤡 🤡 🤡

TYPE 2: Earning a platform token by using the product

This is the deFi version of “play to earn” like in crypto gaming.

Some deFi platforms reward user activity with their native token to encourage more activity. The Ponzi element is a bit less acute than in, say, Axie Infinity, because the activity you do, e.g. trading, has a clearer utility to others. But in the end they are similar.

(BTW, you can check out my thoughts on Axie Infinity here.)

Also these are more wages than yields, since you’re not passive. And what you earn is a native token that doesn’t do much, and 100% tied to project survival.

Theoretically a “governance token” allows you to vote on project direction. But if you’re not a whale, your vote doesn’t mean a lot. Plus letting democracy decides product direction is less cool than it sounds.

Henry Ford would tell you, “If I’d asked people what they wanted, they would’ve said faster horses.” Are the herds of 21st century so much less stupid than the herds of 20th century? I don’t think so.

Ponzi score: 🤡 🤡 🤡 🤡 🏰

TYPE 3: Liquidity pools in AMMs

LPs are tricky yields.

When you add tokens to a liquidity pool in AMMs like Uniswap, you earn a fee when people swap btw the two tokens in the pool. But unless prices for the two tokens move in unison, it’s very possible that you’re worse off even after the fee, compared to simply holding the tokens.

But you can use LPs to rebalance portfolio automatically. You add to a ETH-stablecoin pool. ETH price goes up. You get less ETH and more stablecoin. ETH price goes down. You get the opposite. It forces you to automatically buy the dip and sell the hype.

@victorrrlam pointed me to a nice article on under what conditions this would work better than simple hodl.

So yes there are strategies to make money from LPs. But most people won’t execute well and they are not easy yields.

Ponzi score: 🤡 🤡 🤡 🏰 🏰

TYPE 4: Lending stablecoins to HODLers who leverage long

This is less Ponzi than types 1-3, but may not for the reason you think.

Some people take crypto prices as up only. So they buy $100 of BTC, use it as collateral to borrow $70, buy $70 of BTC and use it to borrow $49, and so on…

If you lend to these guys, when prices are up, you are taking a small share of the gain. When prices are down and the pyramid blows up, as long as it doesn’t happen too often, the platform’ll sell the collaterals so you still get paid.

(This may change as crypto market gets bigger. More than that in a sec.)

The problem is this yield is ultimately tied to crypto prices rising. Right now there’s no integration btw crypto and real economy. The former does not actively add value in the latter. So the upward price of the whole crypto space is based a lot on new money coming in every day.

If you’re thinking, isn’t that the definition of a Ponzi, yes correct.

But the difference, compared to types 1 and 2, is that your yield is not tied to an individual project. Instead you’re taking a stake in the broader crypto ecosystem b/c the borrowers can take your loan to buy a variety of tokens.

DeFi and other blockchain use cases, once integrated with the real economy, can unleash a wave of disruptions and efficiency gains. The day that happens is the day crypto as a whole stops being a Ponzi.

And with that, the stablecoin yields will turn into the real deal. It doesn’t mean the current yield level won’t change. But that’s a longer discussion for a sequel article.

Ponzi score: 🤡 🤡 🏰 🏰 🏰

TYPE 5: Receiving a platform token as dividend

This yield itself doesn’t depend on “up only”, but you’re getting a platform token whose price depends on market condition. So overall a tie with Type 4.

An example is Sushi Swap’s xSUSHI. This is like a stock dividend. Sushi takes a cut in swaps and other stuff done on their platform. You provide Sushi with liquidity in the form of holding xSUSHI, in exchange for a slice of their revenues.

The platform revenue is not a 1:1 relationship to crypto price going up. As long as there’s price volatility and people are trading in and out, Sushi makes money and so do you.

This is an all-weather, passive yield. More reliable than types 1-3. Your main risk is the underling platform token.

Ponzi score: 🤡 🤡 🏰 🏰 🏰

BTW, like this so far? I write about ideas on investment, macro and human potential. Subscribe to my newsletter for updates.

TYPE 6: Lending to arbitragers

Instead of lending to retail traders who are mostly long, you can lend to sophisticated traders who arbitrage across time (shorting) and across space (exchange price diff).

Since the price margins for short-term arbitrages are not big, traders need to move larger amounts of capital to make it worthwhile. The liquidities on most deFi lending platforms are still not enough for these ops. To lend to this type you have to go to a ceFi platform like Celsius.

That’s why ceFi can offer higher yields for BTC, ETH and even stablecoins, than say, Aave. Because the latter doesn’t have institutional borrowers who trade short term in large quantity. But that may change overtime as deFi volumes grow.

This is a relatively reliable yield since it does not depend on crypto prices going one direction. Large traders can still get rekt. But they tend to have better risk control than most retails and you’re protected to some extent by their collaterals.

But the biggest protective factor is what I’ll talk about below.

Ponzi score: 🤡 🏰 🏰 🏰 🏰

In the end nothing gets 🏰 🏰 🏰 🏰 🏰. Because everything in crypto is at least a bit Ponzi right now.

The deFi maxis would say, “Prices dropped a lot in March 2020 and May 2021, but deFi didn’t break. That shows how robust the thing is.”

I think not.

Crypto is a tiny part of financial system right now. When prices drop 80%, enough liquidity rushes in to pick up bargains. The entire fiat system is the lender of last resort for crypto, and does so with ease because the beast is still small to feed.  

When traders get margin called in crypto, they can move funds from elsewhere to cover it. But what happens when crypto grows so big that it BECOMES the system?

You see it in 2008 crisis and similar crises before it: all asset prices drop sharply system-wide and there is little liquidity anywhere to save any particular market.

DeFi platforms can liquidate collaterals to pay you, the depositor. But that only does any good if the collaterals are still worth something in a black swan event.

The black swans will not be so black as long as fiat liquidity is backstopping crypto. The bigger crypto becomes, the less true that will be.

This post is getting long and stinky. I’ll write another on what the long-term yield would be in crypto. For now, 🤡 🏰 🏰🏰 🏰 is good enough. Bye!

p.s. Platforms mentioned are examples, not endorsements. None of this is financial advice.

 

2 Comments

  1. I would reconsider the wording here: “arbitrage across time (shorting)” arbitrage typically refers to a simultaneous event that is risk free. This does not apply here. If it was a risk free event across time there would be no gain or an information asymmetry involved, e.g. insider trading. From my point of view it is speculation.

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