Yield Farming on Binance Smart Chain: APYs and Risks

Aug 12, 2021

Mettalex has been a happy member of the Binance Smart Chain’s family since February 2021, but as of July 14th, six of the DEX’s markets are already BUSD yield farms. That is why we decided to take a closer look at BSC and compare some of the popular yield farming pools and farms with Mettalex.

Why Binance Smart Chain?

Binance Smart Chain (BSC) is generally perceived as a gas fee-efficient and lighter alternative of Ethereum and this is by design – an EVM-compatible blockchain network that comes without the congestion and exuberant transaction fees. It achieves its efficiency through the Proof-Of-Stake Authority consensus mechanism that uses 21 community validators rotating every 24 hours.

BSC has many other advantages which have turned it into a popular destination for DeFi, NFTs, and gaming dapps – currently around 750 projects are being built on it. In fact, according to a recent Messari report, Binance Smart Chain has been the most used network by developers in Q2 of 2021. Its secret hides in the way it is being developed – the network is totally customer-centric and delivers what the development community and the users need.

Taking all this into account and adding the skyrocketing transaction fees on Ethereum, it is no wonder that by May 2021 BSC managed to attract around 13% of Ehereum’s TVL (total value locked). In reality, BSC’s main goal is not to outcompete Ethereum but rather to push the whole DeFi space forward. As Julia Tan, Biz Dev at BSC commented, every future dapp will be integrated in every other blockchain and the whole space will be interoperable so it doesn’t matter where a project was initially built.

In the spirit of DeFi’s development, it would be more relevant to look into another metric – namely the volume on decentralized exchanges (DEXs) as a share of that on centralized ones (CEXs). Messari reports that it started to rise again for the first time since the 2020 DeFi Summer and surpassed 10%. That just shows that the space has matured enough to resist the recent market corrections and is ready for another jump ahead.

Mettalex also embraces interoperability as an essential goal on the way towards DeFi’s mass adoption. Apart from launching yield farming in the DEX using Binance’s stablecoin BUSD, one other step in that direction was opening a dedicated BNB market. The Binance Coin is the “fuel” of both Binance Chain and Binance Smart Chain, and a multitude of BNB use cases are emerging, including in DeFi. BNB has achieved spectacular growth since the beginning of 2021 and we are delighted to welcome its 500K holders to trade or supply liquidity on Mettalex.

Yield Farming As the Engine Behind BSC’s Growth

“Yield farming is the practice of staking or lending crypto assets in order to generate high returns or rewards in the form of additional cryptocurrency. In short, yield farming protocols incentivize liquidity providers (LP) to stake or lock up their crypto assets in a smart contract-based liquidity pool.”

CoinMarketCap

Yield farming is what bank deposits are in traditional finance – you let the bank operate with your money in exchange for interest. Of course, risks are much higher in the crypto world but so are the returns. The established banking system has greatly minimized risk but has also contributed to decreasing the value of money.

The booming expansion of Binance Smart Chain over the last year has been boosted exactly by yield farming. In fact, the most popular applications on the network – those controlling 65% of all the platform’s funds, are PancakeSwap – a decentralized exchange, and Venus – a decentralized lending protocol – both popular yield farming destinations.

Evidently, yield farming can be practiced on different types of protocols, such as AMMs, (Automated Market Makers), yield aggregators, lending and borrowing or NFT platforms. Consequently, returns on deposits vary depending on the platform: for instance, a lack of supply for lending on a lending protocol would push rates up to attract more liquidity.

The most popular yield farms are actually decentralized exchanges. In exchange for providing liquidity there farmers earn the so-called LP tokens which consequently can be staked again in return for both transaction fees and additional tokens.

If you go to Binance Smart Chain’s dedicated Yield Farming Dashboard you’ll see its star-farms, as well as the main parameters characterizing the different liquidity pools – namely cryptocurrencies forming the trading pair, TVL, rewards token, impermanent loss, and APY.

When choosing where to deposit their cryptocurrencies, liquidity providers (LPs) are mostly interested in the APYs i.e. the profit they may generate, and the impermanent loss factor, which is one of the main risks in yield farming.

APYs

“The annual percentage yield (APY) is the real rate of return earned on a savings deposit or investment taking into account the effect of compounding interest.”

Investopedia

APY is the yearly interest earned on your deposit. Bear in mind that liquidity pools may sometimes display APR instead of APY which is not the same thing:

“APY, or annual percentage yield, takes into account compound interest, but APR, which stands for annual percentage rate, does not. APR represents the annual rate charged for earning or borrowing money. The more frequently the interest compounds, the greater the difference between APR and APY.”

Investopedia

Make sure to research well what amount of rewards you should expect to receive prior to investing your crypto. Offering exuberant APYs may often be not more than just a marketing trick or a scheme masking a potential rug pull:

“A rug pull is a malicious maneuver in the cryptocurrency industry where crypto developers abandon a project and run away with investors’ funds. Rug pulls usually happen in the decentralized finance (DeFi) ecosystem, especially on decentralized exchanges (DEXs), where malicious individuals create a token and list it on a DEX, then pair it with a leading cryptocurrency like Ethereum. Once a significant number of unsuspecting investors swap their ETH for the listed token, the creators then withdraw everything from the liquidity pool, driving the coin’s price to zero.”

CoinMarketCap

In DeFi it is possible to stumble upon an APY reaching 8,000% but you should ask yourself if it is worth the risk. Generally speaking, the higher the return, the higher the risks. If we are to compare different pools on PancakeSwap, the highest APY available revolves around 250% but the risk of impermanent loss there is high.

Actually, the only pools where the probability of impermanent loss is low is where the trading pair comprises two stablecoins and almost no volatility is expected. For example, both the USDC/BUSD and the USDT/BUSD pairs on PancakeSwap offer around 7% of yearly APR and a low risk of impermanent loss.

Impermanent Loss

If you decide to provide your liquidity to a pool or a farm, impermanent loss is a risk you should always factor in, except if you are using Fetch.ai’s DeFi Agents that could protect you from it.

The term “impermanent loss” represents the difference in the value of the tokens if provided in an AMM liquidity pool and if held in your wallet. Trading activities change the ratio of tokens in the pool and thus affect the value of deposited liquidity. The more the difference in value, the more impermanent loss the LP suffers. It is possible for that loss to be compensated with the change in token prices, and it becomes permanent only if the liquidity gets withdrawn.

Therefore, the higher the volatility of one or both of the assets in the pool, the higher the impermanent loss. In the most common case, a pool comprises two cryptocurrencies in a 50:50 proportion, whereas to diminish the danger of impermanent loss, one of them is a less volatile asset or a stablecoin. However, other models have emerged where the exposure to the more unstable cryptocurrency is minimized to only 20%, 5%, or even 2%, in pools with proportions 80:20, 95:5, and 98:2, respectively. It has been proven that the impact of impermanent loss is limited in these cases but it is not erased completely and LPs’ yields may still be affected.

Thus, the factors to consider when calculating the probability of impermanent loss at a certain point in time are the following: the average price change and the weight of each of the assets in the pool. The higher the weight of a more volatile asset results in high impermanent loss.

Yield Farming on Mettalex DEX

Most of the Mettalex markets are now yield farms providing a variable APY of ~20% – a rather generous yield rate compared with other programs. At the same time, it is worth mentioning that Mettalex’s protocol is designed to minimize risk for liquidity providers as much as possible. The DEX is generally not suitable for more volatile assets since it was developed to enable the trade of comparatively stable traditional commodities.

So, by combining these two parameters, yield farming on the Mettalex DEX is turning out to be one of the most profitable and secure options out there. An APY of ~20% for a stablecoin yield farm is among the highest available in the DeFi space.

However, yield farming is never totally risk-free. As more trades are executed on the DEX, the LP risks will diminish further and the trading fees will augment the APY in anyMTLX tokens. All potential risks of yield farming on Mettalex are described here – make sure you consider them before investing your crypto.

Conclusion

The benefits of providing liquidity may indeed outweigh the risk of suffering impermanent loss, but it should not be treated lightly. Yield farming is not a game even if it may sound like it. You should always research the project behind the cryptocurrency you invest in and make sure it is backed by a substantial development activity, a team of professionals in their respective fields, and enough capital. New projects looking to attract users and liquidity will always promise higher returns but also hide more dangerous risks.

We’ll leave you with a great quote from Messari wishing you “Happy Yield Farming!”:

“The famous “set and forget” strategy that once dominated liquidity provisioning has become antiquated and suboptimal. In this new world, the highest returns will flow to those who research, develop and successfully implement active management strategies by constantly updating liquidity ranges to capture the highest amount of trading fees.”