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, .
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 .
[Matt: ] .
[Joe: ] . 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, .
[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 ?
[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: ] 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. 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.
 “Ponzi Scheme” is hardly fair:
Sick of people calling everything in crypto a Ponzi scheme. Some crypto projects are pump and dump schemes, while others are pyramid schemes. Others are just standard issue fraud. Others are just middlemen skimming of the top. Stop glossing over the diversity in the industry.
— Pat Dennis (@patdennis) April 25, 2022
 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.”
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: