A question that I’m reminded of during the bull run 2020-2021 DeFi bull run was “how are the yields so high?”

The simple answer was that the governance tokens, or psuedo equity were what allowed for people to take ownership of protocols and get them at a significant discount.

The mythical death pool is the best example – the pool with the highest APY was the one with the governance token paired with an asset like ETH. The challenge here being that despite the high APY, the principal was decreasing significantly in value.

Underlying the story is that a yield trick – where people were bamboozled into comparing debt like returns to the volatility of an equity like investment.

This happens on a much smaller scale in TradFi – where boomer retail buys Exxon or other large cap high-dividend stocks for the stable returns that they provide, not realizing that the overall moves in the underlying equity move the needle much more than whatever meager dividend income there can be from a stock.

The key issue underlying this is that it’s easy grok the return profile of a bond (look at the coupon, default risk, etc), and stocks – but DeFi sits at a weird inbetween.

There’s reduced principal risk (if you don’t consider hacks), but there’s more equity like exposure.

Broadening this out – many of the largest protocols within DeFi someway or the other can be explained through this lens:

• Uniswap has the most classic story – while the UI shows triple or double digit APYs LPing on various pairs, whether its a combination of LVR/IL or LPing on shitcoins – facing significant loss on principal when all said and done.

  • Not to say that LP’ing has never been profitable (being the counterparty to so much retail flow), but the average LP is a net loser all things considered.

  • I think the Uniswap story in particular is very illuminating – these tricks predate token based incentives, and that token incentives are very much an accelerant/integral to these tricks

• Alchemix is classic – people turning what equates to a yield stripping protocol and completely throwing duration risk out of the window – to which the ALCX holders have paid dearly.

• Olympus was self explanatory – thousand percent APYs per rebase, only for people to figure out the rebase was no different than a large stock split for the majority who were staked

• Luna is probably the epitome of a misunderstanding of APYs – people farming 20% APYs to the tune of billions, without realizing that they were the yield.

• Ribbon and other structured products market a high APY for staking into a Ribbon vault – while people didn't realize on the other end they were getting slaughtered selling vol to marketmakers and losing their shirts on principal.

• Bunni, Velocimeter and others doing options tokens

  • this is almost the most naked version of this yield trick, where the use of options tokens allows protocols to increase the APY in the UI without actually meaningfully increasing inflation – simply by the virtue that unlike selling tokens outright, not all of the options tokens will be redeemed.

The list goes on and on…

Conclusion:

Rounding it out, this is not an indictment of DeFi and the innovations in particular. I do think that it’s a critical way to think about DeFi and keep an open mind of the mechanisms that take. These yield tricks are an integral part of the DeFi story and I don’t think taking these tricks out will be effective as a GTM strategy in the near to medium future. Each large stepchange in the DeFi meta can be explained using a misunderstanding of yield via these yield tricks.

I also think that part of the reason that many of these protocols have had many forks, and consequently have faded out so quickly – mainly because the game theory of the yield trick gets figured out especially as people try successive iterations of this – in other words people stop participating.

Some positive areas of directions that have resulted:

• There’s now plenty of people thinking about how to reduce LVR, and Uniswap v4 is a marvel of engineering that allows really cool mechanisms to be built to better service liquidity.

• Bond Protocol and Baseline protocol build off of the initial issues around Olympus to create unique capital bootstrapping techniques for protocols.

• Ribbon is using their firehose of option vaults to drive retail volume to their L2 derivatives exchange.

These yield games are worth playing because of the new directions that we can explore, but I do like to think we’ve almost come full circle to TradFi, which has a similar practice of selling complex structured products in the name of easy yield to HNWI and making boatloads of money.

Stay safe out there, especially from yield tricks :)