DeFi abandons Ponzi farms for ‘real yield’

Decentralized finance is beginning to embrace a hot new phrase: “real yield.” It refers to DeFi projects that survive purely on distributing the actual revenue they generate rather than incentivizing stakeholders by handing out dilutionary free tokens.

Where does this real yield come from? Are “fees” really a sustainable model for growth at this early stage?

It depends on who you ask. 

The DeFi ponzinomics problem is our natural starting point.

Ponzi farming

DeFi started to arrive as a concept in 2018, and 2020’s “DeFi summer” saw market entrants — DeGens — piling headfirst into DeFi to early mind-blowing returns of 1,000% a year for staking or using a protocol. Many attributed the real explosion of interest in DeFi to when Compound launched the COMP token to reward users for providing liquidity. 

But these liquidity mining models were flawed because they were based on excessive emissions of protocols’ native tokens rather than sharing organic protocol profits.

Liquidity mining resulted in unsustainable growth, and when yields diminished, token prices dropped. Depleting DAO treasuries to supply rewards programs — or simply minting more and more tokens — for new joiners looked like a Ponzi scheme. Known as “yield farming” to some, others preferred to call it “ponzinomics.”

Yield farming was behind “DeFi summer.” Source: Cointelegraph

While recognizing these returns were unsustainable, many sophisticated investors became enthralled with staking (locking up tokens for rewards). One VC told me they paid for their lifestyle by staking tokens during 2020–2021 — even knowing it was akin to a Ponzi scheme about to collapse. 

The dangers of unsustainable yields were seen in mid-2022, when the DeFi ecosystem and much of the rest of crypto were gutted in a handful of days. Terra’s DeFi ecosystem collapsed with grave contagion effects. Its founder, Do Kwon, is wanted by South Korean authorities and is subject to an Interpol “red notice” but says he is “not on the run.” High-profile hedge fund Three Arrows Capital (3AC), which heavily invested in Terra, was liquidated in June 2022.

The reality is that “returns based on marketing dollars are fake. It’s like the Dotcom boom phase of paying customers to buy a product,” says Karl Jacob, co-founder of Homecoin.finance of Bacon Protocol — a stablecoin backed by United States real estate. 

“20% yield – how is that possible? Marketing spend or digging into assets are the only way to explain those returns. This is the definition of a Ponzi scheme. For an investor, high yield indicates a tremendous amount of risk.

Henrik Andersson, chief investment officer of Apollo Capital, notes the yield in Terra wasn’t actually coming from token emissions. “I wouldn’t call Terra a Ponzi scheme even though the yield wasn’t sustainable; it was essentially ‘marketing money,’” he says. 

Real yield enters the chat

It’s easy to be cynical, then, when the phrase “real yield” started to emerge to popular applause recently. Bankless analyst Ben Giove wrote recently, “DeFi isn’t dead. There are real, organic yields out there,” in a piece explaining that real yields are “opportunities for risk-tolerant DeFi users to generate yield at above market-rates through protocols such as GMX, Hop, Maple and Goldfinch. With the bulk of their yield not coming from token emissions, it is also likely that these protocols will be able to sustain their higher returns for the foreseeable future.”

“Real yield is a hashtag reaction to Terra LUNA’s collapse, but that means people agree more on what it isn’t than on what it actually is,” argues Mark Lurie, founder of Shipyard Software, which operates a retail-focused DEX, Clipper.exchange.

“I’ve been on the real yield train for a year and a half — and I’m glad someone is paying attention.” He says there are a few potential definitions, “but sustainable returns on capital is one that actually makes sense.”

“An example of real yield is interest on a loan, like Compound Finance.” Another example is “fees charged on transactions and returned to capital providers — e.g., gas fees in proof-of-stake layer 1s, trading fees in DEX protocols.”

Real yield is all about sustainable returns on capital. Source: Pexels

Manufactured narratives

Jack Chong, who is building Frigg.eco to bring financing to renewable energy projects, says there are a lot of manufactured narratives in the crypto space. Real yield is one of them, he posits.

“The meaning of real yield depends on which corner of crypto you sit in, and there’s two variants,” says Chong, an Oxford graduate and Hong Kong native. “One definition suggests that real yield is a protocol that has cash flow. It is a digital native cash flow denominated in ETH or crypto.” 

In other words, it’s a business model that has revenue.

“The exact wording of many threads on Twitter is that real yield is staking for cash flows. The distinction is the source of that yield — a lot of crypto ecosystems are self-reflexive,” Chong argues, referring to the digital money circulating and creating gains for investors without coming from actual revenue, like Terra.

“Linguistically, real yield doesn’t have to be about trading protocols,” he continues. “The other meaning is yield from real world assets.” An example is a rental return from a tokenized piece of real estate, such as a fractionalized city car space split among investors.

Chong, who founded a biotech startup and once studied Arabic in Jordan with diplomacy in his sights, has a mission to deploy crypto for productive use. “Any North Star for any financial system should be to deploy capital and make a profit. The whole “real yield” story is just common sense in TradFi, he points out.

Real yield is of course linguistically disparaging of all that came before it as “fake yield.” So, what are these yields?

DeFi will eat TradFi. The key is via Real World Assets (RWA).

But the industry lacks a rigorous case….

So we wrote a 70-page primer to walk through our idea maze