How to avoid losing money when yield farming (part 2)
The past few weeks were pretty rough for the crypto market. The entire market cap shrank from $2 to $1.6 trillion and Bitcoin nosedived from it’s near ATH at $50k handle to sub $30k.
Amidst the crypto carnage, despite
- A trillion dollar asset class crashing 42%
- Cascading liquidations caused by tons of people using up to 100x leverage getting wiped out
- Asset prices crashing by 70% or more
- The lack of regulations
There were no open ended losses, no spill over systemic effects to the broader financial world, and no need for tax payer bail outs.
Yet this new financial system held up.
And in so doing passed another one of the most rigorous stress tests in recent times. Bitcoin has yet again proven itself to be an anti-fragile market where ownership of assets is clear, and limited only to speculators. Not gonna lie, if anything, that was the only thing that had me smiling when my portfolio took a huge crap.
So You Wanna Be Your Own Bank?
There’s never a better time to get involved in yield farming than in periods like these, when crypto’s grinding sideways and lacking a clear momentum. Because who doesn’t want to continue making some dough in an indecisive market?
I’m pretty sure you’ve read all about liquidity mining by now (but if not check it out here). We all know these DeFi protocols carry some serious potential, but the lofty yields also come with some disclaimers. And it’s important to protect our hard earned stash from rug pulls, or hacks resulting from incompetent developers.
So before you go all in on that 1,000% APY liquidity pool platform you’ve been eyeing for a while now, here’s what I’ve learned.
Liquidity
Simply put, liquidity is the ability to get your funds in/out, in the shortest timeframe possible.
Stick with the large caps as much as possible. The larger the community, the faster the adoption and development, which invariably results in better market capitalization and liquidity. The potential for price manipulation would be lower, which is good for everyone.
Market Cap is a good broad base indicator, but should not be the only metric you look at. Wash trading and bots are extremely common to create an illusion of volume. But never mistake activity for liquidity.
Here’s a list of top projects by Total Value Locked (TVL) on Ethereum and Binance Smart Chain. There are also projects building on other chains such as Solana, Polkadot, Huobi, Tron, etc, but these are not scaling as fast as the 2.
As a general rule of thumb, steer clear from the lower cap projects which have a TVL of < USD 3 billion, unless you’re pretty sure you know what you’re doing.
Diversify and Manage Risk
A wise woman once said “Don’t hold all your eggs in one basket” — this holds true especially for a nascent asset such as crypto. Definitely many ways to get rekt here, so caveat emptor!
Asset class
Depending on your conviction on Bitcoin, it’s always good to dip your toes in the water first. After getting a lil’ more comfortable with crypto’s nuances (volatility price swings, operational upkeep, inherent risks), feel free to supercharge your stake. In the meantime, balance your portfolio with TradFi assets like equity, fixed income, real estate and even *gaspp* liquid cash.
Wallets
Here’s a tip on how to organize your your funds. Knowing how to transfer, track and stake your assets is extremely important if you want to yield farm effectively. You wouldn’t misplace your bank/securities statements details now would you?
I remember holding my breath the first time I was transferring and staking my funds. Because there was no hotline to call and absolutely no recourse, it’s best to always do a small test trade/transfer first.
As with all things, this will eventually become as second nature as entering your login credentials in the TradFi world when accessing your funds in a bank.
Staking Chains and Projects
This requires more legwork and some understanding of the different DeFi protocols. But the TLDR is that Ethereum (ETH) chain has been around for longer time, is more decentralized (bigger community/more applications) and have lower yielding projects. In contrast, Binance Smart Chain (BSC) has been around for less than a year, have fewer nodes supporting the network (more centralized) but have higher yielding projects.
In general, a more centralized chain such as BSC could be subjected to governing control by minority consensus, but at the same time, be able to deploy resources more quickly than a decentralized one such as ETH.
Valuing a Project’s Credibility
There isn’t an established framework like CAPM or DCF model as of yet, but things are slowly falling into place as we go along. You’re kinda like a VC since you’re buying into the project and staking your funds onto their platform. This is by no means an exhaustive checklist, but it’s what I tend to look at it from 3 broad angles when trying to value a project.
Features & Incentives
- Innovation — Is there any USP to the project?
- Does the use case make sense? Are there moats?
- Are there actual use cases for tokens and are the tokens distributed fairly?
- Is the project centralized or decentralized?
- How is the tech infrastructure and plumbing?
Quantitative metrics — Fully Diluted Value (FDV), Tokenomics
Founding Team
- Do the founders have a name to their faces? Are they reputable?
- Do they have skin in the game?
- Who are they affiliated with? I.e. are there any big funds/VCs backing the project?
- What is the technical competence of team — do they have a track record / have they been hacked before?
- Is there any possibility of a rug pull? (low team credibility, unrealistic returns, large spendings on promotions, ambiguous white papers)
Quantitative metrics — Certified Audits, Previous Hacks, Lock-up period
Adoption and Community
- How big is the community? What stage is the project at?
- What is the demographics of the community centered around the project like? Mindless shillers or people who actually help to improve the project?
- Are there applications being built on their projects? I.e. do others believe in or share their vision?
- How is their social media presence like?
Quantitative metrics — Price, Trading Volume, Market Cap, Total Value Locked (TVL), Number of addresses holding the tokens
Use Common Sense
Platforms are changing their staking and incentive rewards all the time. But when u see 2000% APYs on that latest hyped project, you need to ask yourself questions like “Where is the yield coming from? Is it sustainable? Is there a real use case backing the project?” If it’s unclear, it’s probably a degen ponzi play and you need to get out asap.
When all else fails, this would be your last line of defense, so you might wanna check in with a friend if you’re still unsure. Unless of course it’s your friend who pulled you into it in the first place 👀.
Fortune Favors the Brave
“Risk comes from not knowing what you’re doing.” So if you know what you’re doing is risky and still end up losing your money, then you probably deserve it.
But hey, what’s life without a bit of living eh? Crypto and Defi are here to stay (feel free to check back in 5 years from now) so the sooner you get up to speed with it, the better.
Sure the wiring may not be fool-proof at this point in time but that’s what makes the rewards so fulfilling. As long as you don’t become overly fearful or greedy, and don’t put in more what what you can afford to lose.
Good luck out there.
P.S. Nothing in this post is to be considered legal or financial advice. All of the writing here is meant for information and entertainment purposes, so DYOR and make decisions based on your own beliefs.
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