- There are various types of yield farming protocols based on utility and tokens staked.
- David Malka details the variations and the due diligence investors must do before trying it.
- Enormously high yields, a lack of utility, or a low total value staked are all red flags.
On August 27, 2021, David Malka, who had spent seven years as an equity trader, was playing a game of musical chairs. But instead of risking his seat, it was more like risking the shirt off his back.
He was yield farming, an application of decentralized finance, or DeFi, that pays out yields in exchange for depositing crypto into a shared pool. In this instance, Malka was on a very new and risky protocol called Frost Finance. So he decided to film himself trying it out.
Frost Finance was offering outrageous APRs of 37,000% to 47,000% at the time of his recording. Was it a Ponzi scheme? Definitely, Malka said. In a typical Ponzi, the investor pays out juicy ‘returns’ from a shared pool with all the clients’ deposits.
But why did Malka do it? First, he claimed to have earned about $14,000 worth of tundra, the platform’s native cryptocurrency, in an hour. During the nine-minute video, he made about $1,000 within seven minutes. One tundra was trading just below $7,000 at the time.
Secondly, he’s a gambler literally. Malka played professional poker online for about seven years, winning tournaments such as the 2016 Seminole Hard Rock Poker Showdown, which earned him $658,000. So when it came to this high-stakes protocol, he took it like a gamble.
“You have to buy a complete shitcoin, deposit it in this yield farm it’s going to pay a really high yield,” Malka said. “And then eventually people are going to take all their profits out of this yield farm and sell that shitcoin as fast as possible.”
The video shows him weaving in and out of the protocol using tundra paired with a crypto called wrapped AVAX. He would dump his bag every time he noticed high selling pressure. Malka told Insider he did this for about six hours until he took his earnings and traded them for USD coin.
As for Frost Finance, the music eventually ended, and all the chairs were gone. The price of tundra crashed and burned. By January, it was trading below $1. As of Monday, it was at $0.53.
Malka, who’s now the CEO of Yieldfarming.com, an educational platform that teaches users about yield farming, says there are probably thousands of these types of schemes that have zero utility. They offer very high returns that aren’t sustainable, creating inflated, short-term demand.
“Eventually, the selling pressure overwhelms the buying pressure, and the music stops,” Malka said.
For now, Malka is still playing the game. He has a cost basis or original value of about $777,800 on yield farming since October 24, 2021, according to a screenshot of his account on Koinly, a crypto tax tracker. His profile on DeBank, a DeFi platform tracker, showed an overall value of about $2.5 million as of Tuesday, meaning he had gained over $1.5 million.
Tony Dhanjal, the head of tax at Koinly, viewed both documents and said that DeBank’s overall value was an accurate reflection of his portfolio’s value. Dhanjal said in an email to Insider that the figures above display the best available information to gauge a return on his investment.
Most of Malka’s earnings from yield farming came from risky protocols that approach may not be for beginners, especially at a time when token holders are seeing steep losses in their portfolios. He also has assets staked across a variety of platforms that require regular monitoring. Some of the underlying cryptocurrencies are volatile and have dropped by as much as 90% year-to-date. This also impacts the overall value of his gains.
Not all yield farms are created equal
Yield-farming protocols are not all are Ponzi schemes or high-risk.
Hannes Graah, the founder and CEO of Gro, a company that creates products that combine DeFi and traditional technology, says a project must provide utility to be sustainable. Usually, these platforms provide
for lending protocols or trading on decentralized exchanges. As a participant, you contribute crypto to that liquidity pot.
Malka said that while there isn’t a ton of utility in yield farming, at a high level it allows you to be the bank. Traditional finance requires an intermediary like a bank or exchange to provide liquidity and execute transactions. In DeFi, that intermediary is replaced with smart contracts, while the lenders are decentralized users earning the interest.
Dan Reecer, the chief growth officer at Acala, a platform that’s building out DeFi protocols including yield farming, says yield farming is more of an early marketing expense for user acquisition than anything permanent. The intent behind the high rewards is that users will remain on the platform once the yields end.
“It does depend on the tokenomics of the specific project, but it usually is kind of a temporary or fixed-duration-campaign type of a thing,” Reecer said.
Malka agreed with this statement but described the approach as no different from a company granting customers loyalty points to incentivize them to use its credit card. However, Malka added that cryptocurrencies such as stablecoins are an integral part of DeFi protocols, so while yields may be reduced over time, they are very rarely eliminated.
Lowering the risk
Malka began yield farming in the spring of 2020 to earn a market-neutral yield, a strategy aimed at reducing a portfolio’s risk by generating returns that are not dependent on the market. In traditional equities, this can be equivalent to a bond. In crypto, the approach works best with stablecoins such as USD coin or tether because they are pegged to the value of the dollar. About 30% of his staked assets are in stablecoin protocols, he said.
Graah said that depositing a stablecoin in a lending protocol is probably the most conservative approach to yield farming. It has very limited risk because you’re not betting on the price movement of any specific crypto asset, he added.
But it doesn’t mean that investors won’t have any risk exposure. Graah pointed out that even within stablecoins, there’s a broad spectrum. On one end, coins can be backed by the dollar and audited regularly. On the other end, they can be backed by nothing more than an algorithm.
Malka noted that stablecoins not fully backed by the dollar face the risk of getting depegged, meaning their value can drop below $1.
“For every issuance of USDC, they put $1 in the bank account. Somehow if there’s a lot of selling on USDC and it drops to, like, $0.97, they can literally take money out of their bank account and go buy USDC back up to $1. So that’s an example of a temporary depegging,” Malka said. “But a riskier stablecoin, like USDT [Tether], it’s not backed one-to-one. So if it fell to $0.75, they can’t actually take dollars out of the bank account and go buy it back up to $1.”
On Saturday, terra’s UST depegged when it plunged to $0.90 in response to high selling pressure. As of Friday, it hadn’t recovered.
Another risk Malka pointed to is a rug pull, which he described as when developers of a protocol just steal your money by withdrawing large sums of crypto from the pot and sending it to their wallets.
Finally, Malka said, there’s the risk of exploits or hacks through vulnerabilities within the smart contract. Malka pointed to the hack earlier this year of Wormhole, a bridge that links ethereum to solana’s blockchain. Hackers walked away with $320 million.
Reecer highlighted the increasing number of anonymous or “undoxxed” teams behind DeFi projects as a red flag, obscuring whether the teams and developers have relevant experience.
What to consider before yield farming
While there’s no way to guarantee safety, Malka says investors should do three things before trying a yield-farming protocol.
First, get familiar with a metric called total value locked, or the sum of all staked crypto assets within a protocol that are earning yields. He recommends using a website called Defi Llama, a TVL aggregator tracking the dollar value of coins staked in different protocols.
Malka said that, generally, anything above $1 billion in TVL is going to be very safe, indicating that massive funds deposited their money in the protocol after doing their research. As an example, he pointed to Curve, which had about $16.4 billion staked as of Monday, according to Defi Llama.
He said a TVL of$100 million to $1 billion is medium-risk, adding that once a protocol slips below $100 million in staked funds, it becomes high-risk. For example, tundra had a TVL of only $40 million.
Second, link a browser wallet such as MetaMask required to connect to these DeFi protocols to a hardware wallet rather than a centralized exchange.
Third, navigate to the protocol’s website and read through its documentation. Malka said that specifically you’re looking for whether the project has been audited, meaning a security firm has reviewed the smart contracts on the platform for vulnerabilities. Ideally, you’ll want to see multiple audits, Malka said.
“If they have audits, and if you click on the audit and actually read it and make sure that they have no critical items, then that is generally a good indicator that the protocol is pretty safe,” Malka said.
He added that if you want to go deeper, see who the auditors are and how many other notable protocols they’ve audited. He said there are about 10 respected companies, including CertiK, Trail of Bits, Quantstamp, Paladin, and OpenZeppelin.
Overall, Malka’s biggest tip is to start small. Set up a MetaMask wallet and a hardware wallet, then deposit just $100. Move this amount to a yield-farming platform like Avee or Curve, wait a couple of days to get some returns, and withdraw your profits and principal. Do this a few times before you increase your position.
Reecer added that if the yields seem too good to be true, don’t take the risk.
A widely highlighted issue with how the structure of yield farming is set up is known as impermanent loss, which is when the value of the token is lower at the time of withdrawal than when it was deposited. This happens when traders take advantage of
in asset prices and arbitrage crypto. If you’re part of a protocol that provides liquidity to an exchange, the loss from the difference in price comes from the yield-farming pot. Depending on when the farmer withdraws their assets, they could get hit with the losses.
Malka said the losses are trivial for most yield-farming positions because the yields are typically higher than the losses. He recommends using a free impermanent-loss calculator to determine the possible margins on each protocol.