In DeFi (Decentralized Finance), yield-based strategies refer to the practice of earning a return on investment by participating in various yield-generating protocols or platforms. It includes:
1. Lending and borrowing: Users can lend their assets to borrowers and earn interest on their holdings. Conversely, borrowers can borrow assets by providing collateral and pay interest on their loans.
2. Staking: Users can lock up their tokens in a staking pool and earn rewards in the form of additional tokens or fees.
3. Liquidity provision: Users can provide liquidity to decentralized exchanges (DEXs) such as Uniswap, Balancer, and Curve by depositing tokens into a liquidity pool. In return, they receive a portion of the trading fees generated by the DEX.
4. Yield farming: Users can leverage their capital to farm high-yield tokens by participating in liquidity mining programs offered by various DeFi platforms. Yield farming involves staking or providing liquidity to earn rewards in the form of new tokens or native platform tokens.
Actively-managed strategies have multiple advantages over yield-based strategies. A few key factors are mentioned below.
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* Impermanent Loss: Impermanent loss is a risk associated with providing liquidity to a decentralized exchange (DEX) or automated market maker (AMM) in a yield farming protocol. When the price of the two assets being traded on the DEX changes, the value of the liquidity provider’s assets may be affected, causing a loss that is not present when holding the assets outside of the DEX.
* Volatility: There are no strategies involved with the investment via yield-based protocols. The high volatility of crypto markets can lead to sudden price swings and significant losses for investors. Moreover, yield farming protocols often involve investing in volatile cryptocurrencies, which can increase the risk of losses.
* Liquidity Risks: Yield farming protocols rely on liquidity to function properly. If liquidity dries up or is suddenly withdrawn from the platform, it can result in significant losses for users who have invested in the protocol.
* Algorithmic approach: Yield-based strategies focus on generating passive income through interest or dividends from holding specific crypto assets. These strategies typically involve less active decision-making and rely on stable returns from the underlying assets. These platforms help users earn yields on their cryptocurrency holdings through lending, borrowing, or providing liquidity to the protocol. They use an algorithmic approach to determine interest rates based on market supply and demand.
With yield-based strategies, investors are often limited to a narrow range of assets, which can result in lower diversification and increased exposure to specific risks. The passive nature of these strategies means they may miss out on potential high-growth opportunities that an active manager could identify.
Actively managed strategies offer the potential for higher returns and better risk-adjusted performance. Additionally, actively managed strategies can democratize access to asset management services for crypto investments, allowing investors to participate in digital assets with confidence and security.
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