Mothers, Lock Up Your Sons So They Don’t Practice “Yield Farming” in Crypto

By Lambert Strether of Corrente.

John Maynard Keynes famously remarked that “The process by which banks create money is so simple the mind is repelled. With something so important a deeper mystery seems only decent.” I am sure the same applies to most of crytpo and defi, but here will focus on demystifying one simple form of fraud in crypto: “Yield farming.” After a short build-up, I’m going to quote extensively from an interview on Joe Weisenthal and Tracy Alloway’s really fun podcast, Odd Lots. Notably, when publishing the transcript, Bloomberg had the same problem writing a headline of sufficient aghastitude as I did: “Sam Bankman-Fried Described Yield Farming and Left Matt Levine Stunned.” Bloomberg normally doesn’t write clickbait headlines like this (“Sophie Turner Revealed the Hilarious Reason She Passed on Kendall Jenner’s Met Gala Party Invite” with deck: “relatable”), so I assume they wrote what they did out of sheer desperation. Fortunately, I was lucky enough to have Mothers’ Day as a hook.

By way of introduction, let me deploy a couple of handwaving definitions of “yield farming” from the “Decentralized Finance” (defi) world (you don’t need to worry about abbreviations like “defi,” basically for the same reason that you don’t need to know what’s actually on the menu at “Mom’s”). From Blockworks:

Yield farming is the process of using decentralized finance (DeFi) to maximize returns. Users lend or borrow crypto on a DeFi platform and earn cryptocurrency in return for their services.

Yield farmers generally use decentralized exchanges (DEXs) to lend, borrow or stake coins to earn interest and speculate on price swings. Yield farming across DeFi is facilitated by smart contracts — pieces of code that automate financial agreements between two or more parties.

There’s a lot of jargon here which, again, you can instantly forget, except maybe “smart contracts,” for which you can imagine using your bank account to make purchases on the Internet of Things. (And don’t @ me on the jargon. The complexity is obfuscation, pure and simple.)

Here’s another one, from Binance Academy:

Yield farming is a way to make more crypto with your crypto. It involves you lending your funds to others through the magic of computer programs called smart contracts. In return for your service, you earn fees in the form of crypto. Simple enough, huh? Well, not so fast.

Yield farmers will use very complicated [uh oh] strategies. They move their cryptos around all the time between different lending marketplaces to maximize their returns. They’ll also be very secretive about the best yield farming strategies. Why? The more people know about a strategy, the less effective it may become. Yield farming is the wild west of Decentralized Finance (DeFi), where farmers compete to get a chance to farm the best crops.

For DeFi — and here I may not be completely fair to a field of great integritude and technical ingenifity — you can imagine using your bank account to make purchases on the Internet of Things, in a completely unregulated environment (“All my apes are gone“).

And now let’s turn to the Odd Lots interview. Alloway (“Tracy”) and Weisenthal (“Joe”) are the interviewers. Matt Levine (“Matt”) comments. Sam Bankman-Fried (“SBF”), founder and chief executive officer of FTX Cryptocurrency Derivatives Exchange, is an honest-to-gosh crypto squillionaire, so he knows whereof he speaks. Alloway, Levine, and Weisenthal didn’t exactly fall off the turnip truck yesterday. But even they are increasingly aghast (“stunned”) at what Bankman-Fried has to say. Asked for a definition of yield farming:

[SBF: ]Let me give you sort of like a really toy model of [yield farming], which I actually think has a surprising amount of legitimacy for what farming could mean. You know, where do you start? You start…

“You,” here, are the insider who hopes and needs to cash out in time.

[SBF: ]…. with a company that builds a box and in practice this box, they probably dress it up to look like a life-changing, you know, world-altering protocol [implementation of a smart contract] that’s gonna replace all the big banks in 38 days or whatever. Maybe for now actually ignore what it does or pretend it does literally nothing. It’s just a box. So what this protocol is, it’s called ‘Protocol X,’ it’s a box, and you take a token. You can take ethereum [a brand of Bitcoin] you can put it in the box and you take it out of the box. Alright so, you put it into the box and you get like, you know, an IOU for having put it in the box and then you can redeem that IOU back out for the token.

So far what we’ve described is the world’s dumbest ETF [Exchange-Traded Fund] or ADR [American Depositary Receipt] or something like that. It doesn’t do anything but let you put things in it if you so choose. And then this protocol issues a token, we’ll call it whatever, ‘X token.’ And X token promises that anything cool that happens because of this box is going to ultimately be usable by, you know, governance vote of holders of the X tokens.

An undertaking of great advantage, with token-holders voting on how to use it, if indeed it it usable.”

[SBF: ]They can vote on what to do with any proceeds or other cool things that happen from this box. And of course, so far, we haven’t exactly given a compelling reason for why there ever would be any proceeds from this box, but I don’t know, you know, maybe there will be, so that’s sort of where you start.

And then you say, alright, well, you’ve got this box and you’ve got X token and the box protocol declares, or maybe votes by on-chain governance, or, you know, something like that, that what they’re gonna do is they are going to take half of all the X tokens that were re-minted [emitted by the box]. Maybe two thirds will, two thirds will offer X tokens, and they’re going to give them away for free to whoever uses the box. So anyone who goes, takes some money, puts in the box, each day they’re gonna airdrop, you know, 1% of the X token pro rata amongst everyone who’s put money in the box. That’s for now, what X token does, it gets given away to the box people. And now what happens? Well, X token has some market cap, right? It’s probably not zero. Let say it’s, you know, a $20 million market …

And here Matt breaks in:

[Matt: ] Wait, wait, wait, from like first principles, it should be zero, but okay.

Exactly. How I wish we still had the HTML <blink> tag, so I could give Matt’s objection the formatting it deserves. Anyhow, to be clear, what we’ve done is construct an empty box, cut a slot on the top, paint “FREE $$$” on the outside, and people are putting money in the slot. That’s a neat trick! Here is how Bankman-Fried responds:

[SBF: ] Uh, sure. Okay. Completely reasonable comments…. I acknowledge that it’s not totally clear that this thing should have market cap, but empirically I claim it would have market cap.

[Matt: ] I agree.

[Joe: ] It shouldn’t have any market cap in theory, but in practice, they always do. Okay.

Yield farmers seem to have a very solid grasp of human nature. Like all con artists.

[SBF: ] This is a pretty cool box, right? Like this is a valuable box as demonstrated by all the money that people have apparently decided should be in the box. And who are we to say that they’re wrong about that? Like, you know, this is, I mean boxes can be great. Look, I love boxes as much as the next guy. And so what happens now? All of a sudden people are kind of recalibrating like, well, $20 million, that’s it? Like that market cap for this box? And it’s been like 48 hours and it already is $200 million, including from like sophisticated players in it. They’re like, come on, that’s too low. And they look at these ratios, TVL, total value locked in the box, you know, as a ratio to market cap of the box’s token. And they’re like ‘10X’ that’s insane. 1X is the norm.’ And so then, you know, X token price goes way up. And now it’s $130 million market cap token because of, you know, the bullishness of people’s usage of the box. And now all of a sudden of course, the smart money’s like, oh, wow, this thing’s now yielding like 60% a year in X tokens. Of course I’ll take my 60% yield, right? So they go and pour another $300 million in the box and you get a psych and then it goes to infinity. And then everyone makes money.

[Matt: ] I think of myself as like a fairly cynical person. And that was so much more cynical than how I would’ve described farming. You’re just like, well, I’m in the Ponzi business[1] and it’s pretty good.

[Joe: ] At no point did any of this require any sort of like economic case, it’s just like other people put money in the box. And so I’m going to too, and then it’s more valuable. So they’re gonna put more money in, and at no point in the cycle, did it seem to like, describe any sort of like economic purpose?

[Tracy: ] Can I just ask on this point, I mean, so are you saying that the value has to derive from everyone agreeing that it’s worth something?

[SBF: ] It’s not just cryptocurrencies that have had this dynamic, right? How about like, you know, AMC or Hertz or GameStop or meme stocks in general have like a very similar pattern to this and the sort of concept of maybe people will pay something for it even though it doesn’t seem traditionally valuable, is not a crypto specific concept.

(“Traditionally” is doing a lot of work, there.)

* * *

Well, I just hope the insiders get out in time[2]. This is America, man. Of course, at this point I feel — I don’t know how to quantify this — that most of United States economy (the “dynamic” and “innovative” parts, at least) is based on fraud; certainly the FIRE sector. So it’s only natural that crypto would be normalized, along with all the other forms of fraud. I don’t know how to reconcile that future with also becoming an autarkic “arsenal of democracy” (Ukraine; Taiwan; etc.) over the next decades, but perhaps the smart people have it figured out.

NOTES

[1] “Ponzi Scheme” is hardly fair:

[2] The term of art is “rug pull.” In the words of the old joke: “They call it an investment vehicle because it’s designed to drive off with your money.”

APPENDIX

I’ve linked to this before, but it’s work hoisting it in the context of this post. It’s long, but worth watching or listening:

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This entry was posted in Free markets and their discontents, Guest Post, Market inefficiencies, Regulations and regulators, Ridiculously obvious scams, Technology and innovation on by .

About Lambert Strether

Readers, I have had a correspondent characterize my views as realistic cynical. Let me briefly explain them. I believe in universal programs that provide concrete material benefits, especially to the working class. Medicare for All is the prime example, but tuition-free college and a Post Office Bank also fall under this heading. So do a Jobs Guarantee and a Debt Jubilee. Clearly, neither liberal Democrats nor conservative Republicans can deliver on such programs, because the two are different flavors of neoliberalism (“Because markets”). I don’t much care about the “ism” that delivers the benefits, although whichever one does have to put common humanity first, as opposed to markets. Could be a second FDR saving capitalism, democratic socialism leashing and collaring it, or communism razing it. I don’t much care, as long as the benefits are delivered. To me, the key issue — and this is why Medicare for All is always first with me — is the tens of thousands of excess “deaths from despair,” as described by the Case-Deaton study, and other recent studies. That enormous body count makes Medicare for All, at the very least, a moral and strategic imperative. And that level of suffering and organic damage makes the concerns of identity politics — even the worthy fight to help the refugees Bush, Obama, and Clinton’s wars created — bright shiny objects by comparison. Hence my frustration with the news flow — currently in my view the swirling intersection of two, separate Shock Doctrine campaigns, one by the Administration, and the other by out-of-power liberals and their allies in the State and in the press — a news flow that constantly forces me to focus on matters that I regard as of secondary importance to the excess deaths. What kind of political economy is it that halts or even reverses the increases in life expectancy that civilized societies have achieved? I am also very hopeful that the continuing destruction of both party establishments will open the space for voices supporting programs similar to those I have listed; let’s call such voices “the left.” Volatility creates opportunity, especially if the Democrat establishment, which puts markets first and opposes all such programs, isn’t allowed to get back into the saddle. Eyes on the prize! I love the tactical level, and secretly love even the horse race, since I’ve been blogging about it daily for fourteen years, but everything I write has this perspective at the back of it.

32 comments

  1. Darthbobber

    Am I missing something, or is this basically just a batch of coinages covering operations exactly like those already common with non-crypto currencies?

    Reply
      1. Darthbobber

        Was thinking of both the literal Ponzi schemes and the host of pump and dump operations that differ slightly in that the pumped asset still has SOME value after the smart money bails, but considerably less than what the dumb money ponied up.

        Reply
  2. anon y'mouse

    the description given makes it sound like a virtual slot machine or a pachinko game or something.

    is it just a set of digi-funds you’re loaning out at interest? why the “random winning” thing if it’s just a return on a short term loan?

    or am i totally confused again? <—-my constant base assumption, btw.

    Reply
  3. Wukchumni

    …is Schrödinger’s Coin taken yet?

    MLB umpires have a couple of FTX badges on their uniform, but I don’t get it really. The average age of a baseball fan is nearing 60, and old farts like me laugh at things crypto. (rubs hands together rapidly with a maniacal laugh, in anticipation of the whole shooting works blowing up real good)

    Reply
    1. lyman alpha blob

      Have you seen the new ads with Steph Curry humping the crypto? He flat out admits he is not an expert (which is touted as a positive!) and doesn’t have to really know anything about it to invest, just press the button on the phone app and you’ll be rich!

      The selling point in that ad is completely lost on me, but evidently the kids dig it – https://www.youtube.com/watch?v=gsy2N-XI04o

      Reply
      1. howseth

        So Steph Curry does not make enough money doing what he understands and is great at?
        Cute ad – too bad.

        Reply
  4. Minh Do

    Yield-farming sure bears a striking resemblance to securities lending in buy-side land. I sure hope there are collateral requirements for them farmers, hah!

    Reply
  5. griffen

    At long last, my tulip bulbs will be fairly valued at something more than nil, but perhaps less than $100 gazillion bazillion USian dollars. The wait is finally over! \sarc

    Holy cr*p on a stack of crackers.

    Reply
  6. Oh

    Depend on the FinCrooks to dream up another con. They’ll take your money in any form – crypto or cash or stocks or any other asset will do. America is the land of the fool and home of the con.

    Reply
  7. albrt

    The S&P 500 Box seems to be performing poorly today. Somebody should put some more tokens in the box so it will be more valuable.

    Reply
  8. Brian compound interest outlier

    Lee camp afficianado Graham Elwood certainly caught the Max Keiser bug for crypto. It saddens me he has not spent more time hearing the many hours Paul Jay and his former haunt Real News spent with Bill Black from the housing crisis Graham was originally victim of and now in the crypto world he has not yet experienced what YouTube politely calls demonetization. Plus verbiage as my ex manager used to say. The speaker uses ratios like he learned what it means from social media not from basic business calculus or statistics. Was a psych supposed to be a good thing?

    Reply
  9. FreeMarketApologist

    I’m impressed that there’s a whole new generation of ‘inventors’ out there who have come up with financial-ish ways to part fools from their money. The vast majority of them have no material training in financial theory or markets, yet they have invented an entirely new lexicon to bamboozle people with. So bravo to them.

    ‘Yield farming’ at the entry level is the simple appreciation of an asset simply because people have hyped the asset. cf: Beanie Babies. At a possibly more useful level, it’s the loaning of the asset to do something, and you’re paid back the asset plus for it’s use (‘plus’ being a fee, or interest, payable in your crypto currency, or additional amounts of some other crypto). But, at supportable and useful scale, this becomes a crowded trade as everybody who wants return piles in, and the fees paid for the use of the crypto falls through the floor. Since what’s typically ‘paid’ is another crypto, created out of thin air with no intrinsic value, it ultimately becomes valueless. To profit, you must acquire the newest crypto early, and sell it on before it becomes worthless. Old wine, new bottle.

    Reply
    1. Lambert Strether Post author

      > To profit, you must acquire the newest crypto early, and sell it on before it becomes worthless.

      That’s the “honorable” way. Another way is to simply decamp with whatever’s in the box via a “rug pull.” (I’m amazed the crypto dudes have even invented jargon for this. And yet crypto rolls on.)

      Reply
  10. Joe Well

    >>Like this is a valuable box as demonstrated by all the money that people have apparently decided should be in the box.

    This sounds exactly like Silicon Valley investing.

    Except instead of the box being empty, it would contain a voracious cash bonfire (Uber, meal delivery apps…actually most of the Unicorns). On a cash basis, worth much less than nothing.

    Reply
    1. VodkaTom

      “Voracious cash bonfire” – a wonderfully evocative phrase. From the outside I think why can’t I have some of the kindling if there is so much they can just burn it up without need

      Reply
  11. ChrisRUEcon

    There are six hundred ways to Sunday in which I could go off here … but as always, firstly, thanks for sounding the alarm.

    I watched the Miami Grand Prix over the course of the weekend, and had to put up with seeing the event’s main sponsor’s logo everywhere – Crypto.com. The two most irksome things on television right now are Crypto and Gambling App commercials. That juxtaposition is, to put it kindly, a little too on the nose. Didn’t realize Eric Tymoigne’s “Why The Fair Price Of Bitcoin Is $0” got picked up by Business Insider. Those who haven’t read it yet can find it easily using the search engine of their preference.

    I was thinking about how useless crypto is, and I remembered the last time I was at a kid’s birthday party where parents had to buy the “arcade tokens”. This is what the DAO-bros are trying to do with NFT’s – establish an obligation to acquire the crypto. Not bad from a Chartalist POV, I guess … but the NFT is a nothing-burger of theft and deceit … LOL.

    #TongueFirmlyPlantedInCheek #oRpeRHapsNoT

    I’m going to start a non-crypto-coin company to put these charlatans out of business! Gonna grab headlines for being environmentally friendly – no mining, just finding. I have half a mind to make the coins geo-located to poor neighborhoods all over the US – like the places Chris Arnade walks and writes about. It’ll be my version of Darrick Hamilton’s “baby bonds”! Except it won’t be just for babies!

    We shall dispense with the blockchain! The ledger will be a large read-only spreadsheet accessible only during transactions by an intermediary, temporary platform identity. I’ll be lauded for providing improved privacy and not burning the equivalent of Providence, RI’s daily electricity usage to purchase two JPEGs JPEG URLs.

    And speaking of JPEGs, the product will be called LCTs – Legitimately Copyrighted Tokens! The Library of Congress has forms to copyright works of art, you know?! When you buy one of my LCT’s – Les Chimpanzés Animés, pour example – you will get an actual physical package containing all the original sketches, final renderings, and so on together with a form conferring legal ownership to you, the lucky buyer! Then you can go get your MLM on, and make $800 sweatshirt deals or comics or animated movies to your hearts content!

    Yes … this is going to be awesome. Can I call my non-crypto #NakedCoin in honor of this family blog? I’m promising a cut! And race weekend paddock passes when #NakedCoin sponsors the 2024 Miami Grand Prix … 😂

    /fin

    Reply
    1. Noone from Nowheresville

      #NakedCoin needs birds and fungi not those stinking wanna be apes.

      How about a chickadee if you need a C to start? Would you consider adding a sound recording as well. Maybe on vinyl?

      I’d like to hear all about cheeseburgers, say hey to my sweetie, check the fee bees market report and get the local dee dee dee news.

      Reply
      1. drumlin woodchuckles

        The stinking wanna be apes are a perfect expression of everything the crypto currency community stands for. I think the stinking wannabe apes are a perfectly good warning symbol.

        Reply
  12. dk

    I didn’t understand how “60% yield” showed up. I also didn’t understand “[a]nd then everyone makes money,” unless it means everybody liquidates their coins to cash. Why should an exchange institution accept the multipliers claimed by coin operators (the puns around these topics are just atrocious)? Well there’s “stablecoins” at are supposed to represent the backing funds but right now these are crashing too.

    https://twitter.com/concodanomics/status/1523823553052872704

    By the way if (when) the stablecoins crash and liquidation becomes impossible then it’s not pump’n’dump or pyramid, it’s Ponizi, correct?

    Oh but if we can buy assets in the virtual reality “metaverse” then there’s no withdrawal necessary, the X coins can be used directly in transactions for imaginary stuff in that context. But that’s not the context in which we breathe and eat and drink and evacuate in order to live. That physical context doesn’t take care of itself, even though current generations were taught that if they perform the rituals of the abstract culture they will be fed and cared for in the real one. That paradigm is already falling apart because too many people forgot that the actions necessary in the real world are not executed by social gesture alone.

    Reply
    1. Lambert Strether Post author

      > That paradigm is already falling apart because too many people forgot that the actions necessary in the real world are not executed by social gesture alone.

      Well put. Symbol manipulation only puts food on the table for so long….

      Reply
      1. dk

        Symbol manipulation puts food on the table when the manipulation is faithful and accurate, and clearly understood. Sufficient dishonesty or inaccuracy, or incomprehension on the part of the receiver/audience, leads to unintended/unexpected consequences.

        But even when the symbolic communication is straightforward and successful, unknown/unforeseen/misunderstood ambient physical circumstances can still confound the intention(s). Still, survivors have sometimes been able to understand the specifics of such failures, and, variously, adjusted their symbols and their expectations to improve future performance.

        This general approach has sustained our species for generations. It was collectively understood that survival, if not anticipation, of unforeseens required a forked approach: a close adherence to received traditions, and an audience for proposals of well-reasoned divergence from norms, the conservative and the liberal functions. And as long as the whole of the underlying mechanism was understood, human social groups continued to evolve and grow, but increasingly by invoking liberal options, and gradually weakening the *quality* of the conserved heritage(s).

        Information decays for purely physical reasons. It requires nearly perpetual maintenance. Gradual prominence of liberal alternatives was not recognized as the sign (symbol) of dire warning that it is. Even partial successes still benefited many. Atop an eventually global engine of sustenance and manufacture, populations grew to and beyond the scale where fellow species members become each other’s greatest competitors, to the point where the symbolically maintained system itself represents both a path for life and a threat to further life.

        Reply
      1. Skippy

        Not actually Lambert … as there is zero store of labour in tokens when a state is undone or diminished – see Phoenicians dramas … and then square that with what the bible says at the time.

        Reply
      2. Joe Well

        Not healthy for the land that gold was extracted from.

        [arm-wrestling meme with GOLD on one side and CRYPTO on the other with “destroying the earth” in the middle]

        Reply
  13. Dave in Austin

    As a bit of humor about how semi-literate people are removed from thier money this is sort of kinda’ interesting, but on Naked Cap? I

    I’m more worried about the bull market being eaten by “the Bear”, the bull#@!* market in Ukrainian democracy futures which is rising like Crypto in 2019, the monthly trade deficit that has gone up 150% in the past three years. And of course poor Amber Heard…

    Reply

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