A farmer's guide to yield

A farmer's guide to yield

Here's how you can use Nansen to navigate the myriad choices yield farmers might face.

Yield farming is the practice of maximizing return on capital by leveraging different DeFi protocols. Most protocols today require native liquidity in order for their product to function properly. It is for this reason that newly launched projects attempt to attract high capital inflows with alluring Annual Percentage Yield (APY). This increases Total Value Locked (TVL) in the protocol, which makes it more highly collateralized, and decreases slippage (in the case of DEXes). 

You may have found a shiny new yield farm you’re interested in under the hot contracts dashboard. It offers a spread of pools where you can deposit a variety of tokens. You’re thinking of entering a pool, but should you? Which pool do you choose? In this article, we break down the various choices you might encounter, and help you navigate your way through, the Nansen way. 

Understanding the general risks involved

Yield farming is inherently risky. Besides being exposed to the asset risk of holding cryptocurrencies, yield farming generally incurs 3 additional layers of risk:

  1. Smart contract risk -- because you are surrendering your funds to a smart contract, you take on the risk that these contracts might be exploited, whether it is from attackers, or the team itself.
  2. Risk of depreciation in price of the underlying asset -- if the tokens you stake fall in value, the yield obtained might not make up for it.
  3. Impermanent Loss risk -- While some farms offer single asset staking, Certain farms also require users to stake Liquidity Provider (LP) tokens, which expose the user to Impermanent Loss. This occurs when there is a divergence in the percentage price change between the two assets.

Different pool types

There are two general categories of farming pools widely talked about in DeFi. 

Pool 1: Pool 1 farms allow users to stake pre-existing tokens that are already liquid and widely transacted in the DeFi ecosystem. In the months leading up to BasketDAO’s mainnet launch, for example, users were incentivized to stake DPI, an index token issued by another protocol.  

Pool 2: Pool 2 farms require users to take exposure to native tokens issued by the protocol. It is a sort of “secondary pool” to incentivize farmers of Pool 1 to continue holding on to the protocol’s tokens, or to provide liquidity for these tokens, instead of selling them out. 

Pool 2 farms are often highly incentivized with higher APYs because these positions take more exposure to the protocol itself (via ownership of the assets native to the protocol). 

Seeking Alpha

Choosing between the various farms is a difficult decision to make. The Top Depositors dashboard in Nansen will come in handy in analyzing and comparing how other users are making their farming decisions.

You will have to specify the deposit address and the specific token you are looking to track. For a single-asset farm, this would simply be the token contract for that asset. For a LP-token farm, you would have to find the token contract representing that specific liquidity pool. 

Do ensure that you key in the correct number of decimal places for that particular token. You can find the correct number of decimal places for a token by looking for the token contract on Etherscan.

Here, you can sort rows by Tokens Deposited, Incoming tokens, and Outgoing tokens, which represents the amount withdrawn from the pool.

You can also proceed to the Wallet Profiler dashboard to get a high level overview of what type of wallets had interacted with the pool. You can also check whether they have mostly withdrawn their capital in the Token Txs Out column.

Farmers who are farming in pool 1 but not in pool 2 might possibly have a lower confidence in the project. This would be something you want to bear in mind. If a large proportion of the pool is dominated by a few addresses, you would also want to set alerts to notify you of any large withdrawals.

Use both dashboards to compare across different pool offerings, and figure out which suits your yield farming strategy. Found anything special? Let us know on our Discord.

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