It is hugely important to identify good investment opportunities when it comes to making money in the DeFi ecosystem. With so many protocols offering various instruments for efficient capital allocation, finding the right pool can be quite challenging even for experienced professionals. Hunting the biggest number is rarely a good strategy since these are extremely risky investments closer to high-stakes gambling.
On the other hand, low APYs that do not provide better results than many tradfi instruments should not be forming the core of your portfolio. US treasury bonds are a good reference. In 2024, these bonds yielded 4.11% on average which is quite high by tradfi standards. ETH staking can be higher (reaching 8% in May 2023) or lower (2.11% in October 2024) than the US treasury bond yield. Correctly positioning yourself to optimize APY is very important.
DeFi yield optimization
Trying to find the right yield while juggling risks and market volatility is quite difficult. In many cases, you won’t be able to predict the outcome of investment activities exactly. Making educated guesses about the returns and comparing them to what tradfi instruments can offer is a good starting point. Below are some tips for newcomers:
Work with protocols that have good track records. Many platforms are established by reputable founders and have strong development teams behind the scenes. You should also read about interesting protocols on social media platforms like Reddit and Discord. Do not invest in projects that are too young or offer overly risky products like memecoins.
Learn the basics. Understanding the difference between APY vs APR in DeFi is crucial. The latter stands for the flat rate you can expect by investing in the pool. APY is the annualized yield that includes compounding (usually, DeFi yields are compounded daily). While the difference may seem insignificant, the compounding effect can have a profound effect on the outcome of your investments.
Do not invest more than you can lose. It is the most important rule for all newcomers. The crypto industry is notorious for creating overnight millionaires. However, it is also infamous for causing massive financial losses just as quickly. Investors should never invest more than they can afford without borrowing.
Understand gas fees and their impact on yield. Fees have a direct and indirect effect on yields. Some pools have to be adjusted regularly if there is a discrepancy in the ratio of assets (mostly, liquidity pools) meaning that transactions are settled on the chain with some adjustments happening very often and leading to significant fees. On the other hand, high fees may lead to lower asset utilization in pools and reduce yields.
Consider tokenomics and inflation. When it comes to yield farming, where investors stake valuable layer 1 tokens and stablecoins in exchange for rewards in governance or native tokens, you should always look into asset emission and the potential effect of endless supply on the value of rewards. As more investors exit positions and sell their tokens, their value drops due to inflation and oversupply.
These tips will help you search for a good pool and protocol while managing available finances. However, you should be equipped with knowledge about different approaches to farming yields. DeFiLlama tracks over 11,300 different pools across 448 decentralized protocols operating on over 90 chains. How can one navigate this ocean of opportunities?
Yield farming strategies
Finding good pools that provide generous returns without exposing you to excess risks is a hard task for newcomers who simply do not even know where to look. To create a robust strategy, you should be picking pools that align with certain criteria:
Invest in pools offered by established protocols. Avoid noname protocols that have been around for just a couple of months. It is important to work with projects that have good track records, audited smart contracts, and high TVLs. For instance, Nucleon on Conflux offers up to 109% in NUT rewards on NUT-USDT investments. However, the protocol was launched at the end of 2023 and struggled to attract a large audience. Choosing protocols like Convex Finance on Curve which offers 15.05% in CRV/CVX rewards on CRV-CVXCRV investments is a better idea.
Focus on pools with high TVL. In many cases, a higher total value locked means that many investors consider a particular pool trustworthy. You can expect lower APYs in such pools. However, returns are still higher, on average, compared to many tradfi instruments. For example, an investor may believe that investing in the sTLOS-USDC pool on ApeSwap AMM for 4,663% in rewards is a good idea. However, the exposure in this $30K TVL pool is very high due to the use of liquid TLOS staking. On the other hand, Aerodrome on Base pays up to 189% in AERO rewards for OVN-USD+ investments with a TVL value of $18.1 million.
Governance tokens are often better than other types of rewards. One of the prime examples is CRV which is the governance token for the Curve DAO. This is one of the biggest DEXes in the whole ecosystem and has a valuable governance token with a sizeable $286 million market cap and over $82 million daily trading volume. These tokens do not suffer from the same level of inflation as many native utility tokens issued by other DEXes.
Liquidity mining rewards can be quite high. DEXes have to compete for liquidity and offer generous rates to investors. Checking out liquidity pools that have massive rewards is a good idea. You should not forget about TVL numbers and protocol credibility as mentioned previously. In 2024, The Open Network seems to be one of the best destinations for liquidity miners. For example, DeDust, a large TON exchange, is offering up to 18.7% in TON rewards to investors who put assets into the TON-USDT pool. The reward is paid on top of a healthy 3.62% base APY.
Build a strategy by carefully choosing good pools from the list of over 11 thousand available options in the expansive DeFi sector. Use the tips above to avoid weak or questionable investments.
Crypto lending platforms as an alternative
While it does feel nice to hunt for the biggest APY number, staying safe is a more important priority for many investors who want to preserve capital. Conservative strategies often revolve around investing in pools on lending platforms that have consistent rates and often outperform high-yield bank accounts and US treasury bonds.
Below are several examples of lending pools that have good rates and high TVLs:
Morpho Aave offers a massive rate of 22.5% on USDT investments. The 30-day mean average APY is considerably lower in October (11.99%) but yields can also outperform expectations. Even at 12%, it is a much better proposition than a typical US high-yield bank account (close to 5%).
Moonwell on Base is strongly focused on providing the necessary liquidity and operational assets to investors interested in trading on Aerodrome. The AERO pool has a hefty 18.68% base APY and up to 1.95% in WELL/USDC rewards. The pool has a solid $12.6 million TVL.
Aave V3 is pushing its stablecoin GHO and has a massive pool ($114 million) with a solid 14.92% base APY. The 30-day average in October was 15.37% but it was even higher in August and September. If you are interested in working with algorithmic stablecoins, it can be a good choice.
Usually, returns on investments in lending pools are considerably lower with Aave offering less than 0.1% on many pools with either low utilization or overcollateralization. However, it can be a good destination for capital allocation if you have a chunk of assets that you want to preserve.
How to improve decentralized finance returns
Many contemporary investors have an idea that one must focus on diversification despite many studies indicating that concentrated portfolios often outperform diversified ones. There should be some diversification and the use of hedging instruments. However, it is important to remember that your goal is not to diversify and protect investment from every possible danger. It is to build wealth and optimize profitability.
Overly focusing on risk-adjusted returns when building a portfolio can be detrimental in the long run. Leaning toward higher ROI is, arguably, a better strategy than focusing on finding the true balance between risk and reward.
Below are several ways to utilize your capital in risky yet potentially incredibly rewarding ways:
Use liquid staking. Protocols like LIDO and MakerDAO allow users to stake ETH and DAI respectively while receiving staked versions of tokens in exchange. As an example, you can use stETH and use it as collateral on Aave to borrow USDC at a 5.65% borrow APY. Staking USDC on Compound V3 yields 8.87% in base APY and 0.25% in COMP rewards for a total of 9.12%. Combined with LIDO’s 2.92% base APY on ETH, you can expect to gain 6.39% under perfect conditions which is relatively safe and allows you to continuously utilize staked ETH tokens.
Focus on yield aggregators. Some protocols offer a unique service of automatically managing your assets by investing them in protocols that offer the best terms. For example, you can stake ETH with Instadapp Lite which has an 8.73% base APY, or go to Yearn Finance and use wrapped ETH to earn 4.89% on top of what you get from staking. The same Yearn Finance also has stablecoin pools with surprisingly high returns. For instance, you can invest in the USDC pool and earn 5.08% APY and 6.08% in rewards for a grand total of 11.16%. RIVO.xyz also offers a selection of carefully selected indexes allowing investors to earn up to 6.3% on Stablecoins.
There are many other ways to improve yields without significantly increasing the exposure. While yield stacking with liquid staking can be dangerous and aggregators may utilize risky strategies, you can still expect to gain more compared to investing in tradfi instruments. In general, smart contract yield generation is a slightly riskier venture than putting fiat in high-yield bank accounts or buying US treasury bonds. Some experts argue that the S&P500 index has been outperforming many DeFi products for a while driven by the expansion of the AI bubble.
These considerations are valid and must be contemplated by any investor. As always, we recommend focusing on DYOR (doing your own research) and making investments after learning as much as possible about protocols that caught your attention.
Risks associated with yield farming and staking
The list of potential dangers that any investor encounters when investing in the DeFi sector is quite long. However, some risk factors are more impactful and important than others. Below are some of the most important dangers:
Smart contract design. Security is often compromised in the name of better usability and scalability leading to unforeseen issues and critical vulnerabilities. Audits and security measures added during the development phase can be very valuable. For instance, MakerDAO has a $10 million bug bounty for critical vulnerabilities in their code.
Insufficient liquidity. Despite the best efforts from AMMs and DEXes, the lack of liquidity is still a big problem. Large trades are often accompanied by slippages. In 2022, the decline in available liquidity was noticeable, to say the least. In just six months, it dropped from the ATH of over $180 billion to less than $50 billion.
Impermanent loss is something that negatively affects half of all investors working with UniSwap and many other DEXes. It occurs when the market value of a staked asset drops significantly causing large discrepancies in case of immediate liquidation. Since prices can bounce back, the loss is called impermanent.
The prevalence of scams and rug pulls is also a big deal. We strongly advocate for careful selection of pools and protocols precisely because the sector is plagued by weak or questionable projects. A notable example is AnubisDAO stealing over $60 million. In 2021, the total amount of funds stolen by scammers was close to $2.8 billion according to CipherTrace.
Regulatory considerations for DeFi yield include unclear taxation rules, the lack of KYC/AML practices, and non-existent consumer protection. According to DeFi Pulse, only 2% of all investors use insurance offered by protocols. Others do not have any legal recourse options if something goes wrong. The absence of taxation frameworks is another big problem.
These issues are some of the most important but other types of dangers like unreliable Oracles, low interoperability, market volatility, and centralization risks exist alongside them.
Staking rewards comparison
As a final remark, we are going to provide a table comparing some of the best yield farming options out there. Several protocols, pools, and tokens are mentioned in the table below giving you a surface-level comparison of investment products in the DeFi sector. All numbers are as of October 2024.
