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diff --git a/src/_posts/2021-06-07-adventures-in-defi.md b/src/_posts/2021-06-07-adventures-in-defi.md deleted file mode 100644 index f5a5879..0000000 --- a/src/_posts/2021-06-07-adventures-in-defi.md +++ /dev/null @@ -1,271 +0,0 @@ ---- -title: >- - Adventures In DeFi -description: >- - There and Back Again, a Yield Farmer's Tale. ---- - -It's difficult to be remotely interested in crypto and avoid the world of -decentralized finance (DeFi). Somewhere between the explosion of new projects, -implausible APY percents, complex tokens schemes, new phrases like "yield -farming" and "impermanent loss", rug pulls, hacks, and astronomical ethereum -fees, you simply _must_ have heard of it, even in passing. - -In late November of 2020 I decided to jump in and see what would happen. I read -everything I could find, got as educated as I could, did some (but probably not -enough) math, and got to work. Almost immediately afterwards a giant bull -market hit, fees on ethereum shot up to the moon, and my little yield farming -DeFi ship was effectively out to sea. - -For the past 200 days I haven't been able to tweak or withdraw any of the DeFi -positions I made, for fear of incurring so many ethereum fees that any gains I -made would be essentially wiped out. But the bull market is finally at a rest, -fees are down, and I'm interested in what the results of my involuntary -long-term experiment were. Before getting to the results though, let's start at -the beginning. I'm going to walk you through all the steps I took, as well as my -decision making process (as flawed as it surely was) and risk assessments. - -## Step 1: The Base Positions - -My first step was to set aside some ETH and BTC for this experiment. I was (and -remain) confident that these assets would acrue in value, and so wanted to hold -onto them for a long period of time. But while holding onto those assets, why -not make a little interest on them by putting them to use? That's where DeFi -comes in. - -I started with 2.04 ETH and 0.04 BTC. The ETH existed as normal ETH on the -ethereum blockchain, while the 0.04 BTC I had to first convert to [renBTC][ren]. - -renBTC is an ethereum token whose value is pinned to the value of BTC. This is -accomplished via a decentralized locking mechanism, wherein real BTC is -transferred to a decentralized network of ren nodes, and they lock it such that -no individual node has access to the wallet holding the BTC. At the same time -that the BTC is locked, the nodes print and transfer a corresponding amount of -renBTC to a wallet specified in the BTC transaction. It's a very interesting -project, though the exact locking mechanism used was closed-source at the time I -used it, which concerned me somewhat. - -[ren]: https://renproject.io/ - -### Step 1.5: Collateralization - -In Step 2 I deposit my assets into liquidity pools. For my renBTC this was no -problem, but for my ETH it wasn't so simple. I'll explain what a liquidity pool -is in the next section, but for now all that needs to be known is that there are -no worthwhile liquidity pools between ETH and anything ostensibly pinned to ETH -(e.g. WETH). So I needed to first convert my ETH into an asset for which there -are worthwhile liquidity pools, while also not losing my ETH position. - -Enter [MakerDAO][makerdao]. MakerDAO runs a decentralized collateralization app, -wheren a user deposits assets into a contract and is granted an amount of DAI -tokens relative to the value of the deposited assets. The value of DAI tokens -are carefully managed via the variable fee structure of the MakerDAO app, such -that 1 DAI is, generally, equal to 1 USD. If the value of the collateralized -assets drops below a certain threshold the position is liquidated, meaning the -user keeps the DAI and MakerDAO keeps the assets. It's not dissimilar to taking -a loan out, using one's house as collateral, except that the collateral is ETH -and not a house. - -MakerDAO allows you to choose, within some bounds, how much DAI you withdraw on -your deposited collateral. The more DAI you withdraw, the higher your -liquidation threshold, and if your assets fall in value and hit that threshold -you lose them, so a higher threshold entails more risk. In this way the user has -some say over how risky of a position they want to take out. - -In my case I took out a total of 500 DAI on my 2.04 ETH. Even at the time this -was somewhat conservative, but now that the price of ETH has 5x'd it's almost -comical. In any case, I now had 500 DAI to work with, and could move on to the -next step. - -[makerdao]: https://makerdao.com/ - -## Step 2: Liquidity Pools - -My assets were ready to get put to work, and the work they got put to was in -liquidity pools (LPs). The function of an LP is to facilitate the exchange of -one asset for another between users. They play the same role as a centralized -exchange like Kraken or Binance, but are able to operate on decentralized chains -by using a different exchange mechanism. - -I won't go into the details of how LPs work here, as it's not super pertinent. -There's great explainers, like [this one][lp], that are easy to find. Suffice it -to say that each LP operates on a set of assets that it allows users to convert -between, and LP providers can deposit one or more of those assets into the pool -in order to earn fees on each conversion. - -When you deposit an asset into an LP you receive back a corresponding amount of -tokens representing your position in that LP. Each LP has its own token, and -each token represents a share of of the pool that the provider owns. The value -of each token goes up over time as fees are collected, and so acts as the -mechanism by which the provider ultimately collects their yield. - -In addition to the yield one gets from users making conversions via the LP, LP -providers are often also further incentivized by being granted governance tokens -in the LPs they provide for, which they can then turn around and sell directly -or hold onto as an investment. These are usually granted via a staking -mechanism, where the LP provider stakes (or "locks") their LP tokens into the -platform, and is able to withdraw the incentive token based on how long and how -much they've staked. - -Some LP projects, such as [Sushi][sushi], have gone further and completely -gamified the whole experience, and are the cause of the multi thousand percent -APYs that DeFi has become somewhat famous for. These projects are flashy, but I -couldn't find myself placing any trust in them. - -There is a risk in being an LP provider, and it's called ["impermanent -loss"][il]. This is another area where it's not worth going into super detail, -so I'll just say that impermanent loss occurs when the relative value of the -assets in the pool diverges significantly. For example, if you are a provider in -a BTC/USDC pool, and the value of BTC relative to USD either tanks or -skyrockets, you will have ended up losing money. - -I wanted to avoid impermanent loss, and so focused on pools where the assets -have little chance of diverging. These would be pools where the assets are -ostensibly pinned in value, for example a pool between DAI and USDC, or between -renBTC and WBTC. These are called stable pools. By choosing such pools my only -risk was in one of the pooled assets suddenly losing all of its value due to a -flaw in its mechanism, for example if MakerDAO's smart contract were to be -hacked. Unfortunately, stable pools don't have as great yields as their volatile -counterparts, but given that this was all gravy on top of the appreciation of -the underlying ETH and BTC I didn't mind this as much. - -I chose the [Curve][curve] project as my LP project of choice. Curve focuses -mainly on stable pools, and provides decent yield percents in that area while -also being a relatively trusted and actively developed project. - -I made the following deposits into Curve: - -* 200 DAI into the [Y Pool][ypool], receiving back 188 LP tokens. -* 300 DAI into the [USDN Pool][usdnpool], receiving back 299 LP tokens. -* 0.04 renBTC into the [tBTC Pool][tbtcpool], receiving back 0.039 LP tokens. - -[lp]: https://finematics.com/liquidity-pools-explained/ -[il]: https://finematics.com/impermanent-loss-explained/ -[sushi]: https://www.sushi.com/ -[curve]: https://curve.fi -[ypool]: https://curve.fi/iearn -[usdnpool]: https://curve.fi/usdn -[tbtcpool]: https://curve.fi/tbtc - -## Step 3: Yield Farming - -At this point I could have taken the next step of staking my LP tokens into the -Curve platform, and periodically going in and reaping the incentive tokens that -doing so would earn me. I could then sell these tokens and re-invest the profits -back into the LP, and then stake the resulting LP tokens back into Curve, -resulting in a higher yield the next time I reap the incentives, ad neaseaum -forever. - -This is a fine strategy, but it has two major drawbacks: - -* I don't have the time, nor the patience, to implement it. -* ETH transaction fees would make it completely impractical. - -Luckily, yield farming platforms exist. Rather than staking your LP tokens -yourself, you instead deposit them into a yield farming platform. The platform -aggregates everyone's LP tokens, stakes them, and automatically collects and -re-invests incentives in large batches. By using a yield farming platform, -small, humble yield farmers like myself can pool our resources together to take -advantage of scale we wouldn't normally have. - -Of course, yield farming adds yet another gamification layer to the whole -system, and complicates everything. You'll see what I mean in a moment. - -The yield farming platform I chose was [Harvest][harvest]. Overall -Harvest had the best advertised APYs (though those can obviously change on a -dime), a large number of farmed pools that gets updated regularly, as well as a -simple interface that I could sort of understand. The project is a _bit_ of a -mess, and there's probably better options now, but it was what I had at the -time. - -For each of the 3 kinds of LP tokens I had collected in Step 2 I deposited them -into the corresponding farming pool on Harvest. As with the LPs, for each -farming pool you deposit into you receive back a corresponding amount of farming -pool tokens which you can then stake back into Harvest. Based on how much you -stake into Harvest you can collect a certain amount of FARM tokens periodically, -which you can then sell, yada yada yada. It's farming all the way down. I didn't -bother much with this. - -[harvest]: https://harvest.finance - -## Step 4: Wait - -At this point the market picked up, ethereum transactions shot up from 20 to 200 -gwei, and I was no longer able to play with my DeFi money without incurring huge -losses. So I mostly forgot about it, and only now am coming back to it to see -the damage. - -## Step 5: Reap What I've Sown - -It's 200 days later, fees are down again, and enough time has passed that I -could plausibly evaluate my strategy, I've gone through the trouble of undoing -all my positions in order to arrive back at my base assets, ETC and BTC. While -it's tempting to just keep the DeFi ship floating on, I think I need to redo it -in a way that I won't be paralyzed during the next market turn, and I'd like to -evaluate other chains besides ethereum. - -First, I've unrolled my Harvest positions, collecting the original LP tokens -back plus whatever yield the farming was able to generate. The results of that -step are: - -* 194 Y Pool tokens (originally 188). -* 336 USDN Pool tokens (originally 299). -* 0.0405 tBTC Pool tokens (originally 0.039). - -Second, I've burned those LP tokens to collect back the original assets from the -LPs, resulting in: - -* 215.83 DAI from the Y Pool (originally 200). -* 346.45 DAI from the USDN Pool (originally 300). -* 0.0405 renBTC from the tBTC Pool (originally 0.04). - -For a total DAI of 562.28. - -Finally, I've re-deposited the DAI back into MakerDAO to reclaim my original -ETH. I had originally withdrawn 500 DAI, but due to interest I now owed 511 -DAI. So after reclaiming my full 2.04 ETH I have ~51 DAI leftover. - -## Insane Profits - -Calculating actual APY for the BTC investment is straightforward: it came out to -about 4.20% APY. Not too bad, considering the position is fairly immune to price -movements. - -Calculating for ETH is a bit trickier, since in the end I ended up with the same -ETH as I started with (2.04) plus 51 DAI. If I were to purchase ETH with that -DAI now, it would get me ~0.02 further ETH. Not a whole heck of a lot. And that -doesn't even account for ethereum fees! I made 22 ethereum transactions -throughout this whole process, resulting in ~0.098 ETH spent on transaction -fees. - -So in the end, I lost 0.078 ETH, but gained 0.0005 BTC. If I were to -convert the BTC gain to ETH now it would give me a net total profit of: - -**-0.071 ETH** - -A net loss, how fun! - -## Conclusions - -There were a lot of takeaways from this experiment: - -* ETH fees will get ya, even in the good times. I would need to be working with - at least an order of magnitude higher base position in order for this to work - out in my favor. - -* I should have put all my DAI in the Curve USDN pool, and not bothered with the - Y pool. It had almost double the percent return in the end. - -* Borrowing DAI on my ETH was fun, but it really cuts down on how much of my ETH - value I'm able to take advantage of. My BTC was able to be fully invested, - whereas at most half of my ETH value was. - -* If I have a large USD position I want to sit on, the USDN pool on its own is - not the worst place to park it. The APY on it was about 30%! - -I _will_ be trying this again, albeit with a bigger budget and more knowledge. I -want to check out other chains besides ethereum, so as to avoid the fees, as -well as other yield mechanisms besides LPs, and other yield farming platforms -besides Harvest. - -Until then! |