What are DeFi vaults and how do we use them to farm profits?

What are DeFi vaults and how do we use them to farm profits?


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With the streamlined appearance of numerous DeFi products, users are getting more confused. What is best for the management of their crypto savings? When it comes to long-term storage, DeFi Vault is a comprehensive tool that helps maximize profits by providing the highest yield rates and securely locking assets. Let’s take a closer look at vaults, their different types and how to boost revenue with this technology. 

What is a vault?

A vault is essentially an Ethereum smart contract where users can store their cryptocurrency and get tokens that may be later used as collateral. They work like pools of funds that use particular strategies for maximizing returns on the assets therein. They were created to address the problems of yield farming and liquidity mining by implementing a more complicated approach than simply switching between various lending protocols. 

Vaults vs yield farming

In order to understand why vaults are a more sophisticated technology, we should first underline the peculiarities of yield farming - this is what serves as the foundation.

In order to scale and grow, DeFi apps need users and their investments. That’s why projects turned to yield farming. This process involves putting cryptocurrency into a pool governed by some protocol. Protocols distribute governance tokens to encourage user activity and incentivize early contributors. These tokens can be used for further investments, trading and for voting inside the platform. 

For example, Compound’s protocol established farming around its COMP governance token, which was distributed to past and present lenders and borrowers. The majority of DeFi protocols emerging in 2020 had native token rewards for all liquidity providers right from the start. 

Thus, yield farming boils down to incentivizing users who provide liquidity, lend and borrow on a platform. The amount of passive profit is pre-defined and depends on the tokens and pools chosen (APY might vary according to offer/demand on the market). 

Vault functionality goes beyond putting coins into a protocol. The majority of vault strategies execute multiple actions for reaping profits. They involve:

 

  • Supplying collateral
  • Borrowing other assets
  • Providing liquidity
  • Collecting trading fees
  • Farming other tokens and selling them

How does Yearn.Finance Vault work?

Being one of the pioneers of DeFi and yield farming, the Yearn.Finance platform was the first to introduce vaults and is still the leader in this sector. Today, it’s in the top-10 global DeFi projects, with assets worth over $400 million locked inside its pools. 

Their yEarn aggregator protocol became a groundbreaking yield farming solution because it brought automation to the industry. It started with a yETH vault, where users provided their ETH and the protocol started leveraging it, boosting returns. Participants didn’t have to do anything besides deposit their assets into the vault. 

So far, Yearn Finance offers several active vaults:

  • curve.fi/Compound LP
  • curve.fi/3pool LP
  • curve.fi/y LP
  • curve.fi/busd LP
  • curve.fi/sbtc LP
  • Yearn.finance
  • DAI
  • TUSD
  • USD Coin
  • USDT
  • aLINK

In Yearn Vaults, the strategy is chosen by the Yearn community. Contributors are also rewarded with 0.5% of the yield generated by the vault. When a vault strategy ceases to be efficient, it becomes inactive.

Is Value DeFi Vault different?

In September 2020, the Value DeFi protocol presented its Value Vaults, claiming them to be “the most advanced yield-farming aggregators and strategy deployers available in the DeFi space today”. What makes them special?

Value Vaults are designed to maximize the profits of depositors while reducing gas fees and eliminating platform fees. In contrast with other vaults on the market, the YFV protocol takes no fees. Upon withdrawal, users receive a larger amount of tokens than they initially deposited.

Vaults are being presented in three phases, each expanding on their features and flexibility of LP-pair deployment: 

  1. Public beta, single controller, one type of fund. Three types of staking options are available (WETH, ETH-USDC UNIv2 LP token, ETH-WBTC UNIv2 LP token). Users can join a farming co-operative to save on gas expenses. Value Vaults automatically allocate AUM to find the highest yielding tokens. 
  2. Release Candidate, Single Controller, Multiple Strategies, Flexible Asset Deposits. LP conversion on the fly is enabled. Multiple strategies are capable of allocating capital by capturing and preserving returns, maximizing efficiency and profitability. SLP, UNIv2 LP, BPT and VLP will be accepted.
  3. Final, Multiple Controller, Multiple Strategies, Single Asset to LP Flexibility. More tokens accepted. It’s possible to farm multiple coins by depositing a single asset.

The creators of Value Vaults were inspired by the explosion of liquidity provider tokens (UNIv2 token or SLP tokens). They decided to implement vaults with a flexible ratio and multiple controllers, making it possible to farm two coins by using single-asset fund vaults

Who else offers vaults?

So far, DeFi vaults are a new notion, there are only a few solutions available, for example:

  • Maker DAO allows users to set up and manage vaults.
  • APY.Finance connects with the major protocols and utilizes smart contracts which route users’ assets and offer the most profitable yield farming strategies. For each strategy, it displays an overall risk score based on smart contract, financial and centralization risks.
  • Harvest.Finance automatically farms the highest yield available from the newest DeFi protocols and optimizes the yields received using the latest farming techniques.
  • Rari offers 3 pools (REPT, RYPT, RSPT), each with its own secret strategy. 
  • In AAVE, owners of tokens can open a Credit Delegation Vault with certain parameters (for instance, desired interest rate) and the amount of capital that can be borrowed.
  • YFII Vault is a smart contract governed by YFII DAO. It automatically allocates funds and supports random integration of wallets and exchanges.
  • DeFi Yield Protocol plans to launch its first automated vault in Q1 2021.

We shouldn’t go without mentioning the special tools that are available with vault management. For example, DeFi Saver has released Automation v2 - a vault management automation platform. 

Advantages of vaults

Since the APY rates of pools are subject to constant change, deposits that were profitable yesterday might be absolutely pointless tomorrow. Keeping tabs on the protocols and pools is a challenging task. Besides, the movement of assets from one pool to another costs much gas. Because of poor Ethereum network scalability, huge withdrawal fees might surpass farmers’ earnings - that’s one of the major problems in the DeFi industry.

  1. By providing flexible and smart strategies, vaults prove to be more profitable in the long run. They are more responsive to market changes and bring higher rewards. 
  2. No manual settings are required - strategies are fully automated. Instead of adjusting or redistributing assets, users only need to make a deposit. The rest will be done by the vault.

How to use vaults

To put it simply, the process of using vaults on Yearn.Finance and other similar platforms consist of three steps:

  1. Connect a browser wallet.
  2. Choose a vault and deposit the corresponding assets.
  3. Earn profits and withdraw locked funds when necessary.

On Maker DAO, users generate their own vaults - this is a more complicated process. However, they can customize vault parameters and earn more DAI. 

Is it worth the risks?

While the crypto community is overexcited about the potential rewards, vaults are not devoid of risks, just like any investment tool. Yearn.Finance and Maker DAO warned people about this right from the start.

The threat of asset loss is conditioned by the liquidation risk. If Ether’s price falls to a certain threshold, users’ positions might get liquidated - this is done to ensure the DAI’s peg to USD because DAI is collateralized by ETH at a 200% rate. For instance, on 12-13 March 2020, the MakerDAO ecosystem was affected by the collapse of both capital and crypto markets, which removed over 50% in value from ETH, BTC and other assets. That also caused a huge spike in gas fees.

Other risks are associated with the following truths:

  • In order to interact with smart contracts, users need to spend gas fees. Sometimes crazy commissions simply obliterate earnings, making yield farming absolutely useless.
  • Because of the above-mentioned interaction with multiple smart contracts, several layers of risk are added to the process.
  • It goes without saying, good old-fashioned hacking. Since DeFi is a new sector of digital economics, there are many undiscovered vulnerabilities. Some have concerns about how vaults work exactly. Their codes might be not robust enough and are therefore prone to attacks. 

Wrapping Up

Representing an advanced approach to yield farming, DeFi vaults might be a better solution for the long-term storage of crypto assets. They integrate complicated strategies and connect to the most profitable protocols for maximizing depositors’ revenue. However, this is a completely new instrument that bears huge risks and should be researched further. Like any other financial experiment, there will be winners and losers.

Thanks for reading the article!

The article is written by Vladimir Grinevskiy and Mr. Anton Dziatkovskiy, the co-founder and CEO of Platinum Software Development Company.

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Anton Dzyatkovskii
Anton Dzyatkovskii

I am the blockchain leader, cryptographer. Co-Founder and CEO at Platinum Q DAO Engineering (www.platinum.fund). I am a passionate entrepreneur and a skilled negotiator.


antondzyatkovskii
antondzyatkovskii

Anton Dzyatkovskii is the blockchain architect lead. He is a passionate entrepreneur and a skilled negotiator. He is a hardworking business leader with more than 13 years of experience in different positions within the FinTech, Retail, and E-Commerce sectors. He is also experienced in expanding financial businesses to totally new markets.

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