Thoughts on YFII Tokeneconomics
Summary: Growth should be prioritised over monetisation at this early stage.
A proportion of the profits could be used to subsidise the gas costs for YFII depositors and to create a referral scheme. When they deposit into the vault they could immediately earn 0.01 YFII provided they do not withdraw within a certain length of time (and if they input a referral code then the referrer could receive 0.01 YFII).
This will likely increase the number of people who are able to deposit into the vaults profitably, thus increasing the Total Value Locked (TVL) in YFII vaults. It can also be used as a good marketing tool and make it more inclusive.
Tokens are being given away in return for providing capital. The developers of new protocols are essentially paying people to put their capital at risk to provide liquidity, as a bounty for hackers and to get feedback from users of their protocol.
For an individual the profitability of yield farming depends on the following:
- The amount of the new token being distributed
- The price of the new token
- The amount of capital in the individual’s wallet
- The cost of gas fees for all the transactions required (at a minimum a transaction is needed each for depositing and withdrawing and then further transactions for more complex strategies)
Problem and Progress
As the gas fees increase for Ethereum transactions it prices out potential smaller yield farmers.
Yearn goes some of the way to solving these problems by aggregating yield farming as follows:
Problems and Progress
|1| High initial capital requirement caused by gas fees that price anyone with less than $500 out of yield farming. By pooling capital you can yield farm profitably with $500 each. The constraint is the high Eth gas fees to deposit and withdraw funds into and out of the vaults.
|2| Hard to find the best yield farming strategies by yourself. Huge progress especially with many developers working on it.
YFII can go one step further
YFII can become the first yield farming aggregator to bring the initial capital requirement from $500 to $100 by giving YFII (or other tokens of value) to newcomers to partially offset their gas fees.
For example, if someone wants to deposit 0.1 YFII ($100 when YFII = $1,000) into the YFII vault then they could receive 0.01 YFII subject to certain conditions such as it cannot be withdrawn for an initial length of time. The length of time should be determined by considering the extra earning that YFII can make with the extra capital.
This is similar to the PayPal or Uber model of being paid to use the service or being given something for free.
What do YFII holders want?
In the long-term YFII holders want YFII to have a high market capitalisation due to sustainable profits from yield farming strategies.
Two things are needed for this:
- Developers building strategies to farm out capital (this is being taken care of)
Growth versus Monetisation
YFII is a platform with the following stakeholders:
- YFII holders
It is less than a month since YFII forked (at UTC 16:00 July 27, 2020) therefore it is probably much too early to focus on monetisation. I think it makes more sense to focus on growth at this stage. If YFII increases the TVL then the price will follow and monetisation is the easy part, e.g. buyback and burn is the obvious one.
Where does YFII get capital from?
There are lots of different potential investors in YFII’s vaults:
Potential investors, Risk tolerance, Risk already taken, Understanding of yield farming (table format doesn’t work well here!)
|1| YFII holders | High | Contract risk, price risk | Varies! |
|2| People with $100k to $millions in stable coins (the OG’s of Defi Yield Farming) | High | Contract risk | High |
|3| Crypto investors with over $500 | High | Price risk | Varies |
|4| Crypto investors with less than $500 | High | Price risk | Varies |
|5| Bitcoin miners, e.g. the ones in Chengdu. They may need to use Ren Protocol to convert to ERC-20 | Moderate | BTC price risk | Varies |
|6| Everyone else (no-coiners) | Low | Inflation risk | Low |
The tokeneconomics of YFII should consider how to incentivise the groups above (and any others) to deposit into YFII vaults, instead of into YFI vaults or others as there are lots of competitors now.
One approach to incentivise people is to design the tokeneconomics to get YFII into the hands of more people (without whales dumping!) so that they have a stake in the system, even if it is small. Note how the early Bitcoiners gave BTC away.
This could be done by instead of buying and burning YFII, YFII was distributed to people who deposited in the vaults. This would be the exact opposite of “whales dumping”. This is similar to the Celsius Network model where CEL is distributed to holders of all tokens.
A referral system could be set up so that when you enter the code of the referrer on the depositor page then the referrer receives 0.1 YFII. It costs twice as much to deposit and withdraw at current prices therefore the system could not be abused and it would encourage more depositors which would lead to greater profits for YFII holders. This is commonly used but would need a clever scaling solution with gas fees as high as today.
Should vault depositors receive returns in YFII or the deposited token?
Ideally depositors should have the choice to earn in YFII or in the token that they have deposited.
Key assumption underlying the Buyback and Burn Model
Buying back YFII from the market has the underlying assumption that YFII is cheap in price relative to everything else (including stable coins). In Berkshire Hathaway shares are only purchased when the market capitalisation divided by the book value of the assets is under 1.2. Although this is not an issue now as YFII has only just begun, if there were to be a price bubble and YFII were to become obviously overvalued e.g. based on a TVL / market cap basis, then it could make sense to reduce buybacks and only buy back when the YFII price is lower. The key here is not to guess whether YFII is over-valued but to provide a support mechanism at lower prices, rather than to contribute to price appreciation in a bubble when it is not needed.
Capital appreciation is taxed less than income in many countries therefore buy and burn can be more tax efficient than paying a form of dividends.
Centralised exchanges do not want to miss out on the yield farming governance tokens. 7.5% of YFI is held on Binance and 24% of YFII is held on Huobi and 1.5% on Hotbit (shown in the Etherscan links below).
Centralised exchanges currently offer the following services relevant to YFII:
| No. | Services | Status |
|2|Cheap crypto-to-crypto exchange|Available|
|3|Cheap deposit into YFII vault|Available on Hotbit with min investment of 1,000 USDT, Not yet available on Huobi|
Is Huobi’s next step to offer yield farming returns after amassing 24% of YFII supply? By investing via Huobi, YFII would be losing out on their cut of the profits. YFII needs to keep ahead.
Hotbit already offers investment in YFII Pool 1 Farming, however, the minimum investment is 1,000 USDT which prices most people out of it. Hotbit takes 5% of the profit. That is 5% that is not going to the investor or to YFII with the additional risk of being on a centralised exchange.
Contributing to the gas fees, with a good marketing campaign, could increase the number of people depositing directly in YFII vaults as opposed to on a centralised exchange.
Keep up the good work everyone! I hope you find as least some of this contribution useful!