Before we get started, if you're new to Yearn Finance and need a recap, check out my previous article here. Yearn vaults are funds that are pooled together with a plan for maximizing the value of the asset in the vault. Vault strategies are more active than the standard Yearn protocol's lending out of coins. In reality, most vault methods can optimize profits in numerous ways. This might include offering collateral and borrowing other assets such as stablecoins, providing liquidity and collecting trading fees, or collecting and selling other tokens for profit. Each vault follows a strategy that the Yearn community has chosen.
Yearn vaults were built in response to yield farming and liquidity mining, which made finding the best yield much more difficult than just switching between lending methods. When tokens are put in a vault, the user receives yTokens that can be redeemed for the underlying tokens, similar to the standard Yearn protocol.
When it comes to vaults or the Yearn protocol in general, one of the most important rules is that you must always withdraw the same asset that was first placed. So far, farmed tokens and fees have been sold for the vault's main asset. The amount withdrawn is equal to the amount initially invested, plus the pool yield generated, less the fees. Not everything that is deposited in a vault is accounted for. Vault holdings are distinguished from strategy holdings in the vaults. The majority of the assets are utilised by an active approach, however there is some fund that remains in the vault unused.
When a user withdraws funds from a vault, the funds are taken from the vault's idle portion first, and there is no withdrawal fee. If the funds in the idle portion of the vault are insufficient to cover the withdrawal, the funds must be withdrawn from the strategy, incurring a 0.5% fee.
Furthermore, certain profit-generating strategies will result in a 5% fee to cover gas fees. Currently, 10% of the fee goes to the strategy creator for community-created strategies like the ETH strategy. As a result, a talented developer may find that developing a new vault approach is a good opportunity. Fees that do not go to the strategy developer are placed in a treasury contract. If the money in the treasury contract exceeds the $500,000 limit, the excess is moved to the governance staking contract. Yearn vaults include stablecoin vaults (DAI, TUSD, USDC, USDT), Curve LP vaults (Y, BUSD, sBTC), and non-stable assets (DAI, TUSD, USDC, USDT) (LINK, YFI, ETH).
To further understand the concept of vault strategies, consider the Yearn ETH vault. As already mentioned, the community decides on the approach for each vault. We're working on the current yETH vault running strategy, which may and will most likely change over time. Following a user's deposit of ETH into the vault, the ETH is placed as collateral in a MakerDAO lending platform. The ETH strategy can borrow DAI at a 200 % collateralization ratio by providing ETH collateral to MakerDAO, resulting in a Collateralized Debt Position (CDP). If 10 ETH were placed in the MakerDAO at a rate of $2,500 per ETH, the strategy could borrow up to 12,000 DAI.
Borrowed DAI is then placed in the Yearn DAI vault, which adopts a strategy that deposits DAI in Curve's Y pool, a stablecoin pool that includes DAI, USDT, USD, and TUSD. Because of the Curve's CRV token's current crediting mining program, giving liquidity to the Curve's pool and locking LP tokens in the Curve Gauge now results in receiving additional CRV tokens in addition to the regular trading fees obtained by just supplying liquidity to a pool. The ETH strategy then sells CRV tokens for ETH on a regular basis using the Y liquidity pool's collected trading fees to earn even more interest. When all of these actions are taken together, you may obtain a return of roughly 60% on your ETH placed in the yETH vault. The yETH vault has already reached 370,000 ETH locked in two days after its inception, making it the largest CDP on MakerDAO.
yETH vault has the potential to withstand a large amount of ETH and turn into a virtual black hole for the cryptocurrency. In principle, when more and more ETH is removed from circulation, the price of ETH should rise. One of the most essential advantages of employing vaults is that it allows you to automate your yield farming. Yield farming is a time-consuming and costly activity, so if you don't want to spend hours looking for the ideal yield farming opportunity, pay hundreds of Dollars in gas fees to transfer funds around, and keep track of your collateralization ratio, you should definitely stick to the vaults.
This all sounds great, but don't forget about the potential risks. ETH placed as collateral on MakerDAO is exposed to liquidation if the collateralization ratio goes below 150 %, in addition to the typical DeFi risks of Smart Contract flaws and stablecoins losing their peg to the Dollar. Yearn vaults are certainly one of the most fascinating new developments in Decentralized Finance, but like with much else in DeFi, always be sure to understand the potential risks before deciding to adopt a certain protocol.