To use the term "pump & dump" is a market manipulation that is frequently observed in the crypto world. There is a massive purchase of assets that will artificially increase the price of crypto before suddenly seeing a "release" which therefore causes the price of the token to drop.
And, this is a pattern that we also observe in Yield Farming.
DeFi has opened up new models and original financial structures that facilitate the generation of ever greater returns.
This may surprise newcomers, that's a fact, because we're talking about yields of more than 10% on average for the lowest...Then, we have the famous 4 or 5 digit APYs...
Thus, the high returns offered are not as sustainable as expected and reduce over time. Let’s see here why such a depreciation…
Yield Farming: The framework
Yield farming refers to locking tokens into a pool to earn rewards.
The user who deposits his tokens is called the "liquidity provider" and he provides a service to the pool. For this service, the protocol pays him rewards that can have the following form:
- A portion of transaction fees: providers get a portion of the fees on every transaction that happens in the protocol. This is really the most common form of yield farming actually. Typically, a decentralized exchange like Uniswap offers rewards to the liquidity providers of the protocol. This is typically called “yield farming.” Liquidity mining"
- Interests of borrowers: Here again, lending and borrowing are a very widespread form in DeFi, like compounding and Aave, for example. Users who provide assets are rewarded by borrowers who pay an interest rate to borrow.
- Native Token rewards (reward tokens) : Most DeFi protocols have their own native tokens. It is often with this token that farmers will be rewarded.
You should know that many protocols use compound interest for rewards. This is therefore done automatically with smart contracts. So, instead of showing simple APRs, we have APYs (which are actually APRs with compound interest).
Finally, most protocols will mix all these types of rewards for their users.
We also have what we call yield aggregators which aim to optimize user yields. For example, if you provide liquidity on Uniswap, you will receive an LP token ( Liquidity Provider token) and this is where you can stack it in another protocol for example to generate rewards.
Thus, the liquidity provider will earn two types of rewards (those of fees + native tokens).
Understand Tokenomics of Yield Farming
To incentivize liquidity providers, yield farms often use an inflationary schedule of their native tokens. Very often, their tokens do not have a fixed supply and have an unlimited max supply.
Basically, every time a user deposits liquidity, rewards are paid out in the form of native tokens of the protocol in question. Okay, until then. Users can then accumulate the tokens received or exchange them for other tokens (such as stablecoins for example).
To prevent tokens from becoming too inflationary and losing value over time, yield farms have implemented internal mechanisms to curb inflation. Typically, there are "burn" systems that consist of burning coins regularly. This limits the supply in circulation and therefore curbs inflation.
-> What is Tokenomics: the crypto economy for?
Dumping on yield farms
Frequently, we observe pump and dump patterns when the native token has just been launched and the deflationary mechanisms have not yet been put in place. This explains why very often, the price of these tokens tends to fall very quickly after the launch.
This happened with PancakeSwap which fell by more than 60% in the first days after its launch. Then, the price held steady for a while before resuming a decline marked by the end of 2021…
It should then be noted that Pancakeswap has worked a lot since then on deflationary mechanisms and has even released an IFO platform (launches of new IDO-type projects) where users must stack CAKE tokens to benefit from it.
For what? For many reasons but also partly because farmers will massively sell the tokens received, for example.
How to protect yourself from yield farms with big dumps as it is not allowed?
We have not insisted on the pump function but know that it is often upstream before the dump of a reward token. For the beginnings of a protocol, there is necessarily an initial frenzy that takes place before users go in search of another protocol that is even more profitable.
You must then be very careful about the protocols you choose, and take a good look at the Tokenomics of the project before launching.
Also try to look at the functionalities of the token afterwards, even if only what is planned. A token that will not have other functions does not really have the probability of constantly increasing in value over time.
Also check the processes of the deflation mechanisms which will be used in the protocols to control the inflation of the token.
Then, once again, pay attention to FOMO, the one that will be fed by marketing etc.
Note: No financial advice is given in this or any other article on zonebitcoin. This is information of which you are the sole judge and master. Be responsible with your investments and only invest as much as you are willing to lose.
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