How fast can I grow $1,000 in DeFi: Week 4. A boring but perhaps wise thesis.

May 14th 2021

An updated version of this article can be found here.

Summary:

  • -11% return on initial funds to date, and -4% for the week
  • Rewards earned were about +2% but the effect of falling token prices was -6%
  • I propose a boring but perhaps wise thesis on why farming may only work as part of an asset allocation strategy.

Those new to this series can find the Week 1 article here.

Caveat: I see a high chance that I will lose all of this money. If you plan to do yield farming, I suggest you plan on losing all of your money too.

Week 3 Performance:

Over the third week, net assets reduced to €827.31, down from €867.50 at the end of last week. Here is the breakdown of returns:

a. Rewards — I earned just under €15 in rewards from selling EGG and CAKE tokens, respectively earned farming EGG-BUSD on GooseDeFi and farming XMARK-BUSD on PancakeSwap. Rewards were down from week 2 because the price of these rewards tokens (EGG and CAKE) dropped during the week.

b. Price movements — both EGG and XMARK went down in price, resulting in a decrease in the value of my holdings in liquidity pools by €53.

The plan for Week 4

Updated farming pool. Returns on BUSD-XMARK on PancakeSwap have gone below 200% APR, so I have shifted those funds over to BUSD-KUN, farming on PancakeSwap and with an APR over 300%.

My holdings at the start of week 3 are roughly:

  • 50% BUSD (held in a wallet)
  • 25% EGG-BUSD liquidity pool on GooseDeFi, deposited to the farm on GooseDeFi
  • 25% BUSD-KUN liquidity pool on Pancake, deposited to the farm on PancakeSwap

Reflections from Week 3 — A New Thesis

The tokens that provide high yields are nearly always new and volatile in price. The reason rewards are provided at high levels is because the tokens are new and volatile. Take for example the price history of EGG, which first traded in mid-February, and which I have now been farming for the last three weeks:

Since inception, the price of EGG has varied by an order of magnitude. Even though the rewards rate on farming EGG-BUSD is high, the price movements on a weekly basis are higher.

This leads me to two consistent approaches towards yield farming:

  1. Diversify price risk by farming a large basket of “new tokens”.

I could do this by splitting my holdings to farm many more pools than just the two I am farming right now. Perhaps one would way to filter pools would be to farm all of those on PancakeSwap and Goose Finance with a minimum liquidity of $1M and a minimum APR of 200%.

$1,000 worth would be too little for getting high diversification because of transaction costs. Likely — to hit say 20 pools — I would want to have about $10,000 at play rather than $1,000. In practise, managing this amount of pools would be quite a bit of work, and the returns on $10,000 might not be enough to justify that effort.

Lastly, even if my diversification was excellent, I would be holding a basket of “new tokens” that are likely to be the first to crash in a downmarket. It would only make sense to have a small portion of my overall assets allocated to such a strategy.

2. Use farming only as a secondary complement to an asset allocation approach.

Absent wide diversification across new tokens, an alternative is to ask which tokens/protocols I believe in and am happy to own. Then, only as a secondary matter, I can decide whether or not it makes sense to juice returns by doing farming using those tokens.

I know little about Goose Finance (and the EGG token) and also little about XMARK or indeed KUN. That’s not to say they are good or bad, I just don’t fully understand them. So, my current strategy of farming a small number of pools with tokens I don’t know well is undiversified and a bad one. It would make more sense for me to focus on earning yield on assets that I am happy to own (for example, by staking Ethereum I own or by locking CELO I own to earn interest, which I do already).

It’s a boring conclusion, because I was thinking yield farming could be high profit and fun. Ultimately though, it’s probably a good thing for the ecosystem that yield farming isn’t easy to profit off without carefully choosing which tokens to farm.

It’s hard to get away from the maximum that I should only invest in what I understand.

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