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What is Yield?
As you navigate through DeFi the term 'yield' often pops up. This article explains in simple terms what's yield and provides examples of its sources.
In the most basic terms, yield refers to the earnings generated and realized on an investment over a particular period.
These earnings can come from various activities such as:
- lending (Aave, Compound, Morpho)
- staking (Lido)
- yield farming (Yearn, Harvest, Beefy)
- providing liquidity (Curve, Uniswap, Paraswap)
When you put your tokens to work in one of the platforms above, you shall receive proof of deposit in the form of an interest-bearing token. For example, when you lend USDC to Aave, you receive aUSDC in return. This aUSDC represents your lent USDC plus the interest it accrues over time.
In this case, aUSDC is the interest-bearing token.
Each platform has its own way of describing an interest-bearing version of the input token. For example, Compound has cToken. Which means, that for depositing USDC, you'd receive cUSDC from Compound.
In general, interest-bearing tokens is your proof of deposit which also entitles you to accrued yield on top of it.
Lending: Lending protocols like Aave, Compound, and Morpho allow users to lend their crypto assets to earn yield. For example, when you lend USDC to Aave, you receive aUSDC in return. This aUSDC represents your lent USDC plus the interest it accrues over time. The yield is the interest you earn on your loaned assets.
Staking: Staking involves participating in a Proof-of-Stake (PoS) network to help secure the network and, in return, earn rewards. For instance, you can stake your ETH via Lido Finance to help validate transactions, earning ETH as yield.
Yield Farming: Yield farming involves navigating the DeFi landscape to maximize yield by leveraging multiple protocols. For example, you might lend DAI to Aave to earn interest, then stake that aDAI in a yield farming protocol like Yearn Finance to earn YFI tokens as additional yield.
Liquidity Provision: Liquidity provision involves supplying assets to a liquidity pool (like Uniswap or Curve), enabling other users to trade these assets. In return, you earn a portion of the trading fees as yield. The more liquidity you provide, and the longer you provide it, the more fees you earn.
APR volatility is a significant factor when engaging in DeFi yield-generating activities.
APR (Annual Percentage Rate) is the annual rate of interest without taking into account the effect of compounding. In DeFi, it represents the yearly rate of return you can expect from a lending, staking, or yield farming activity.
However, APR isn't fixed. It can fluctuate based on various factors, such as supply and demand dynamics, changes in liquidity, or even protocol governance decisions. This constant fluctuation of APR is known as APR volatility.
APR volatility can significantly impact your expected yield.
Consider a simple example: you lend USDC to Aave offering a 10% APR. You deposit with the expectation of earning 10% on your investment over the year. However, due to changes in market dynamics, the APR drops to 5% after a month. Your overall return will be much less than initially anticipated, impacting your yield and financial planning.
ARP volatility adds uncertainty to your investment strategy, making financial planning challenging.
In other words, interest-bearing tokens are exposed to APR volatility.
We are all familiar with CoinMarketCap and CoinGecko, which are the primary sources of token prices in the crypto world. They provide essential information for traders and investors to make informed trading and financial decisions.
Key metrics include Base APY, 30-day average APY, and the accompanying chart. Each asset listed on DeFiLlama has its dedicated page, providing a more detailed chart and showcasing its APR evolution.
Equipped with knowledge of yield sources, interest-bearing tokens, and their volatile nature, let's dive into how you can leverage Spectra to unlock more possibilities on top of your interest-bearing tokens.
The problem: an interest-bearing token is a single piece that represents both the principal (initial deposit) and the right to its future yield.
Solution: Spectra splits an interest-breaing token into two derivatives; Principal Token & Yield Token.
This process, known as 'yield tokenization,' unlocks new financial possibilities beyond standalone interest-bearing tokens, such as:
- Fixed Rates
- Yield Trading
- Upfront Yield
- Lending/Borrowing with Principal Tokens as Collateral
- Discounted Assets