In recent months, DeFi has been captured by a new narrative centered around protocols that generate “real yield”. Different exchanges and lending platforms have different ways of calculating, communicating, and at times intentionally obfuscating the APYs their users actually generate, especially when negative. The growing conversation on real yield is an imperfect attempt to address this issue. And while the real yield movement is helping establish a more transparent and practical benchmark for calculating passive DeFi returns, more is needed.
Before the crypto industry settles on the “real yield” buzzword that becomes widely touted yet poorly understood, it’s important to clearly define what real yield is, what it isn’t, and why a better north star metric would be profit yield. To that end, we first look at how most DeFi protocols today strategically define APY figures and why these misleading approaches have become industry standards.
Most DEX LP Yield Figures Are Deliberately Misleading
Decentralized exchanges (DEXs) have an incentive to offer the highest possible returns in order to attract more liquidity providers (LPs) and liquidity. However, many of the eye-watering LP returns advertised by leading DEXs misrepresent the actual amounts LPs earn through these protocols. “APYs” are often theoretical figures almost never realized as an actual gain.
For instance, most of the triple-digital yields that ushered in the 2020 “DeFi summer” were denominated in a protocol’s native token, rather than a more credible, mainstream asset like ETH or BTC. Compound was one of the first projects to start rewarding its LPs with a native token in exchange for their deposits, and the excitement and engagement this triggered inspired countless other DeFi projects to do the same. But these liquidity mining opportunities were only possible because the involved protocols were minting/unlocking and distributing excessive amounts of their native token to keep the flywheel spinning. As a result, the vast majority of these projects were unsustainable, and the moment they brushed against the upper limits of the market’s willingness to absorb their token supply, their token prices plummeted and yield percentages diminished. Who cares if you can earn 400% APY in a protocol’s native token if the token price drops by 80%?
Even more insidious is the misappropriation of the term Annual Percentage Yield (APY). In a TradFi context this term typically applies to your overall profit, expressed as a return on your capital. However, most DEXs today use the term “APY” to refer to the amount of revenue their LPs can earn, while excluding costs an LP may incur over the course of providing liquidity, such as impermanent loss (IL). In other words, within the DeFi space “APY” has come to refer to revenue instead of profit. There are many excuses regarding the difficulty of reporting IL, but at the end of the day this is not an accidental oversight. The fact is, most DEXs need to obfuscate their LP returns in order to attract more users, because the actual returns LPs stand to earn is often minimal or even negative.
It is misleading for DEXs to actively shill impressive APY figures that are denominated in an unsustainable native token that is completely untethered from the protocol’s underlying revenue stream. And it is equally irresponsible for these exchanges to imply that their APYs are profit estimations, rather than top-line revenue figures that ignore costs. By cherry-picking rosy figures to lure in unsuspecting LPs, DEXs like Uniswap have directly hurt users’ earning potential and bottom lines. It’s precisely this sleight of hand that has fueled interest in a more responsible way to calculate and benchmark accurate LP returns.
What Is “Real Yield” Is, and Isn’t
“Real Yield” typically refers to LP returns that come from a share of a DeFi protocol’s revenue, rather than native token emissions. Real yield figures are typically denominated in a mainstream asset like ETH or USDC. Proponents of real yield assert that since these yields are based on a protocol’s actual revenue stream, the returns are more representative of that protocol’s actual operational success and therefore a stronger indicator of long-term sustainability.
The industry’s recent focus on real yield is a positive development, but it’s important to recognize its shortcomings. As it is, the term “real yield” adds credibility to where an LP’s returns are coming from and how these returns are denominated, but there is no standard on whether this figure is expressed in gross or net terms. In other words, real yield figures can be just as misleading as today’s LP APY terms, since most protocols that have adopted this metric fail to deduct impermanent loss and other significant factors from their advertised figures.
For these reasons and more, some DeFi users have expressed concerns that real yield will end up becoming yet another superficial signaling metric, rather than an empirical figure that accurately portrays a protocol’s financial health. What liquidity providers need is a new standard for presenting LP yields that is explicitly based on final LP profit, not revenue.
A New Standard: “Profit Yield”
“Profit yield” is a net returns figure that factors in loss, including so-called ‘Impermanent Loss’, thereby accurately representing the bottom-line returns LPs receive when allocating funds to a DeFi protocol. This means profit yield figures can potentially go negative, which, though alarming, would be far more informative and helpful for LP decision-making than the misleading yield figures commonly used today.
Profit yield is not a new concept. Clipper’s data dashboard factors in account loss when displaying its USD-denominated LP returns. Shipyard co-founder Abe Othman actually wrote a detailed article on how these returns are calculated back in January, and we believe displaying LP returns on a profit basis rather than inflated revenue terms is the most transparent, responsible approach.
Make Yield a Success Metric, Not a Marketing Tool
DeFi users should have a firm understanding of how their LP returns are calculated instead of taking every impressive-sounding term at face value. The DeFi community’s embrace of more transparent and credible ways to calculate and communicate LP returns is encouraging. To that end, “real yield” marks a welcome shift away from the ponzinomics that fueled the early days of DeFi summer. But it is a half-measure that doesn’t give LPs the full picture when it comes to their earning potential – both on an individual protocol level and in terms of benchmarked returns.
Establishing profit yield as the new standard for LP returns would be a huge service for the LPs who underpin the entire DeFi ecosystem, and would make it much harder to pull the misleading sleight of hands most existing DEXs rely on to inflate their numbers and attract LP. In a world where LPs can accurately compare different yield-generating opportunities across different protocols, the main beneficiaries will be DeFi users themselves and the elevation of genuinely sustainable DeFi protocols that drive the entire industry forward.