With the development of DeFi in 2020, anyone can earn interest using decentralized lending and borrowing protocols. The phrase “Yield Farming” started to become a hot keyword, bringing the profit earned from Yield Interest to a new level.
On Ethereum blockchain, everyone is familiar with the protocols that support farming with many different optimizations, but due to the weakness of the Ethereum network - the transaction fees are too high, so there is no protocol to optimize profits when using “compound farming” strategy. But what if other chains have extremely cheap transaction fees?
The other chain with extremely low transaction fees that I talk about is Binance Smart Chain, and the protocol that supports the "compound farming" strategy is Beefy.finance.
So what is Compound farming and what is special about Beefy, let's read more below.
Definition of APR and APY
APR (Annual Percentage Rate) is known as the annual rate of return.
APY (Annual Percentage Yield) is simply understood as the actual annual rate of return that is compounded.
APR, APY differences & examples
APR (Annual Percentage Rate)
For example, if you spend $10,000 on farming GUM-BNB on Pancakeswap platform, the project’s APR is 300% (unchanged), then, at the end of the year, you will receive a total of $40,000 including $10,000 (at the beginning) and an additional $30,000 (300% return on APR).
When you see the APR, it is possible to immediately calculate how much profit will be earned at the end of the year. This profit comes from staking or farming, so it only needs to be done once at the beginning to get the profit.
APY (Annual Percentage Yield)
APY is mostly used for farming projects, depending on which application.
With the APR rate, you will receive 300%/year, but with APY, the 300% rate will be divided by 365 days (each day is 0.82%). Assuming DeFi applications that allow anyone to withdraw at any interest, we will withdraw 0.82% and compound it with the initial money. Repeat this daily or monthly during the farming cycle and you will have the final total APY rate.
For example, when farming a pair of GUM — BNB on Pancake, after you farmed CAKE, you immediately sell CAKE to GUM and BNB. Then, compound GUM and BNB together with the original capital and continue to farm. You will have a much larger APY than the APR received above. That means you will receive a much larger amount of profit than $40,000.
So if you work hard by compounding the capital daily and hourly, will the profit increase significantly? Of course yes, let's come to a simple example when farming a pair of LP tokens with 500% APR, that is, you use $10,000 to farm, at the end of the year you get $60,000. But if you continuously compound the original capital to farm, the APY you get is 20,000%, which means if you put $10,000 into the farm, at the end of the year you will get $2,000,000.
2. How does Auto compound on Beefy work?
As mentioned above, on the Ethereum blockchain, everyone is familiar with the protocols that support farming with various optimizations, but due to the weakness of the Ethereum network, the transaction fees are too high, so there is no protocol to optimize the profit when using “compound farming” strategy.
However, with the low cost advantage of Binance Smart Chain, we can completely sell assets after farming and immediately add to the capital and continue to farm.
On Beefy, Auto compound will automatically handle that without the yield farmer having to handle it manually.
Here is a comparison when farming GUM-BNB on Pancakeswap and on Beefy with auto compound.
Farming GUM-BNB on Pancake, you will have an APR of 300% in 1 year, while with auto compound on Beefy, a profit rate of 0.81% a day will immediately be compounded with the original capital and it will be used to continue to farm, which will give an APY of 1770% a year.
Let’s take a look at the case studies below to better understand how a yield farmer can maximize profits when participating in Yield interest.
First, we will look at a concept that Yield farmers need to understand, which is Impermanent loss (IL).
Impermanent Loss means a decrease in the value of the initial margin cryptocurrency when providing liquidity to AMMs (Auto Market Maker), which are Pancakeswap and Beefy finance in this case. This happens because the ratio between the pair of coins that you provide liquidity changes when the market is volatile.
For example, when you provide liquidity for the GUM and BNB currency pairs. Assume you initially provide 1000 USDT worth of crypto. It includes $500 GUM with each GUM costing $2 and 1 BNB worth 500 USDT.
When GUM or BNB drops in price. For example, if the price of BNB is unchanged, Gum's price reduced by 50% from $2 to $1. So the total value of money you have in the pool decreases from $1000 to $707. So you have to suffer an impermanent loss of nearly 30%. It’s the same when BNB price drops 50% and GUM remains unchanged.
So what if you are a holder who holds only an amount of GUM or BNB without providing liquidity? For example, you use that $1000 to buy GUM. The value of GUM falls from $2 to $1, which means you lose 50% and you have $500 left. The same thing happens when BNB’s price drops.
When GUM or BNB goes up in price. For example, Gum increased by 50% from $2 to $3 and BNB remained unchanged. The total value of money you have in the pool increases from $1000 to $1250. So you have 25% profit.
So, if you are a holder who only holds Gum, with Gum increasing by 50% in value, you will have a profit plus the original capital of $1500.
In this case, you will incur an impermanent loss of 25%.
Estimated temporary loss
So, temporary loss occurs when the asset price in the pool changes. However, what is the amount of temporary loss? Please note that temporary losses do not count towards the fees earned on providing liquidity.
Here is a summary of the chart, which tells us the amount of loss versus holding:
1.25x change in price = 0.6% loss vs HODL
1.50x change in price = 2.0% loss vs HODL
1.75x change in price = 3.8% loss vs HODL
2x change in price = 5.7% loss vs HODL
3x change in price = 13.4% loss vs HODL
4x change in price = 20.0% loss vs HODL
5x change in price = 25.5% loss against HODL
There are some important things you also need to understand. Temporary losses occur regardless of which direction the price changes.
So what is the optimal way to dodge Impermanent Loss?
Method 1: Wait for the ratio between the two cryptocurrencies to restore to the original
Since these are only temporary losses, they will disappear if the exchange rate between the two coins returns to normal
Consider the example at the beginning of the article. If the price of BNB returns to the original of $500, the temporary loss rate will be 0%. However, this way is not optimal due to the unusual fluctuations of cryptocurrencies, the exchange rate between them may never return to the original. At this point the temporary loss becomes permanent.
Method 2: Stop providing liquidity when the market is about to be volatile
This method is very easy to understand. You will not have Impermanent Loss if you do not provide liquidity.
You should apply this when the coin is about to enter a period of strong growth. At this point, the profit of the liquidity provision has not been able to cover the temporary loss, so it is advisable to stop providing liquidity. If it is possible to predict when the token price will grow strongly, we will stop providing liquidity at that time and switch to HODL, and receive all the profits based on that strong increase in token value. (When the good news is out, it is usually a good time to stop providing liquidity and move to the HODL phase)
Method 3: Choose liquidity pools with greater profit than Impermanent Loss
Beefy's Auto Compound, with its extremely high profit, can completely offset the impermanent losses when the value of the tokens in the liquidity pool changes.
These are the knowledge and experience of Black Mamba Venture team. In the near future we will have a change in the interface of the website. We hope you will continue to support us.