Written by @arthurstern
Introduction
With so many juicy yields at every corner, it’s crucial to develop an investigative mindset when evaluating yield farms. I want to highlight a few red flags that are sometimes difficult to spot. Understanding these will help you pick out winners from losers and avoid having to pull out of farms after quickly entering them.
I’ll review three red flags and provide examples of how to spot them below:
- Vesting Schedules & Locked Rewards
- Token Principal Lockups
- Entry & Withdrawal Fees
Let’s get started!
Vesting Schedules & Locked Rewards
Protocols do a lousy job advertising that rewards are vested and not available right away. Examples are FODL, Aurigami, and Defrost Finance, which all vest your farm rewards.
54% APR on USDC is not what you’re earning…
The problem with vesting is that you’re receiving a highly volatile farm token later. Who knows what the price of the asset will be in 12 months? You don’t even know if the project will be alive! Unless the non-vested rewards are high enough or you believe in the project’s long-term success, I recommend staying away from these farms.
Another example is locked rewards. Sperax and Babylon Finance farm rewards advertise a high APR, but they assume that the price of their assets remains fixed during the lockup period (hint: they never do).
You can earn up to 30% APR paid out in SPA on a stablecoin farm by locking your assets for 90 days. Being paid out in SPA means that you will earn a lot less yield if the SPA price depreciates in those 90 days.
Lockups
When you need to lock up tokens to receive extra yield, you must assume the locked up tokens are worth zero! DeFi moves quickly, and even entrenched protocols like Curve might not have the same market share in 4+ years. My mentality is to assume locked-up coins are worth zero, so make sure you’ve calculated that into your returns when entering a farm.
Any lockup mechanic promising a high yield upfront takes into account the price of the farm token. I’m willing to bet PTP won’t have the same value ten months later.
Entry & Withdrawal Fees
You see many of these ‘fees’ in yield aggregator protocols like Beefy Finance and Auto-Farm. While they’re usually low, you need to factor in these costs as they can add up if you constantly get in and out of farms.
Be wary of deposit & withdrawal fees, and calculate them into your expected return.
I’ve built out a calculator with certain assumptions you can toggle, such as slippage costs and entry/exit fees, to help calculate how long you need to be in a farm to be economically viable (Please make a copy for your usage).
Conclusion
While there are still many opportunities to earn a yield on DeFI, it’s essential to dive a little deeper into the reward mechanics for each farm, so you don’t end up being burnt. Make sure to do the diligence upfront, so you don’t have to exit the farm shortly after entering.
If you enjoyed this post, follow me at @arthurstern on Twitter for more DeFi-related content.