DEFI

【Selected ChainNews】Understanding the Core Points of YFI: Fair Distribution, Governance, and Value Capture

2020/7/25

Yearn.finance has transferred control of the entire protocol to YFI holders, establishing a passionate community through fair distribution and governance.

By Daryl Lau, Researcher at Coingecko
Translated by: Jane Zhan
insights.deribit authorized ChainNews for translation and publication in Chinese

Earlier this year, venture capital firm a16z published a blog post titled "Progressive Decentralization: A Playbook for Crypto Product Managers", outlining three key factors they believe are crucial to a project's success:

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Product/Market Fit
Community Engagement
Full Decentralization (Community Ownership)

When this article was written in early January, they mentioned that they had not seen any projects execute these factors in order. However, Yearn.finance accomplished this over a single weekend, with assets under management (AUM) exceeding $4 billion to date, under the most active community engagement. In this decentralized financial DeFi application, leaders and teams from all walks of life came together, handing governance entirely to the community.

Table of Contents

What is Yearn.Finance or $YFI?

Yearn.finance, formerly known as iearn.finance, is an automated DeFi yield aggregator. Before the launch of its governance token YFI last Saturday, its total value locked was around $8 million with an overall yield of approximately 10.5%. Its mechanism primarily involves automated stablecoin savings, utilizing various protocols such as AAVE, Compound, and dYdX to generate yields.

Yearn.finance is a relaunch product that introduces a new set of yield-generating tools, including ytrade, yliquidate, yleverage, ypool, and smart contract credit delegation.

Fair Launch?

The main developer of the project, Andre Cronje, decided to create a token called YFI to transfer control and governance of the entire Yearn.finance suite of tools. Despite having the power to mine first or give himself founder rewards, he chose not to keep any tokens for himself.

At this point, the distribution of YFI is considered one of the most fair in the DeFi community's history, where everyone earning tokens shared the same risk, and all information was freely available to them. This fair launch is reminiscent of early Bitcoin mining, as no one had an advantage in mining—not even Andre himself, as the only way to obtain it was through mining. Like early Bitcoin miners, early YFI yield farmers also chose to align their interests as closely as possible with DeFi benefits, ensuring community enthusiasm and engagement.

How to Earn YFI?

In short, you must provide liquidity to the ecosystem. The initial supply of 30,000 YFI tokens was evenly distributed across three different pools, each with different mechanisms and objectives.

Actual users of the Yearn protocol. All liquidity providers on the Curve.fi yield pool who staked their yCRV earn a corresponding portion of the 10,000 tokens based on their share in the pool within a week.
Liquidity incentives. By providing liquidity on Balancer with 98% DAI and 2% YFI, liquidity providers earn a corresponding portion of the 10,000 tokens based on their share in the pool within a week.
Governance participation. By providing liquidity on Balancer with 98% yCRV and 2% YFI, then staking the Balancer pool tokens (BPT), users not only earn a share of the 10,000 tokens based on their share in the pool within a week but also receive voting power proportionally based on the amount of BPT staked. Voting power is a prerequisite for participating in the fee rewards pool, which distributes protocol fees to eligible YFI stakers in the rewards contract.

Yearn's usage has exploded, with managed funds skyrocketing to over $400 million within less than a week, demonstrating strong product-market fit. According to Defipulse.com data, it ranks fifth in total value locked (TVL) across the entire DeFi ecosystem. However, the question remains about the stickiness of this capital, as they may currently be chasing yields. Importantly, for this yield to materialize, the YFI token itself must have enduring value.

Fair Value?

With governance tokens like Compound, Balancer, BZRX, and now YFI emerging rapidly, the question arises: how do you value governance?

Some believe that the value of a project should be greater than or equal to its total value locked (TVL), as it can be imagined that if its cost is lower than this value, it could pose significant security risks to the protocol, as someone might maliciously attack its governance.

Additionally, if reasonable, governance tokens can vote at any time to decide whether to accept future cash flow/revenue generated by the company, potentially resulting in a premium for the token.

In a related post about the YFI token, Andre stated that the fair value of the YFI token is 0 because there were no sales and never will be, and all tokens must be earned by holders themselves. However, applying the TVL=MC theory, the value of YFI is severely underestimated. Coupled with the fact that everyone is lured in by the generous yields, a "pseudo Ponzi scheme" emerges, with everyone rushing in to provide liquidity, thereby increasing TVL, leading to a feedback loop of rising prices.

It is worth noting that Yearn's TVL actually overlaps with other underlying protocols like AAVE or Curve. One dollar in Yearn can also be represented as one dollar in Aave and Curve. When looking at metrics such as total value locked in DeFi, this should be kept in mind.

Governance, Voting, and Community Power

With the launch of the YFI token came several crucial proposals, each to be voted on by participants in Pool 3.

Proposal 0: Minting YFI

If "For" wins, Proposal 2 will be submitted to determine the weekly distribution quota.
If "Against" wins, no more tokens will be distributed.

If Proposal 0 fails, there will never be new YFI issued, and the total supply will be permanently capped at 30,000 YFI. While this benefits token scarcity and early yield farmers, it does not benefit new entrants and ultimately hinders the growth of YFI. Additionally, existing liquidity providers will no longer have an incentive to continue providing liquidity, leading to a decrease in TVL.

This sparked long debates and discussions in the community, with Proposal 0 appearing to be on the verge of failure for most of the time (31% in favor; 69% against) until the last few hours, when an anonymous "yfi_whale" seemingly pushed the vote towards "For." yfi_whale believed that maintaining inflation, thereby sustaining yield farming, could serve as a way to attract newcomers from a PR and marketing perspective, albeit at the cost of slight dilution.

The necessity of maintaining an inflationary model became evident, but the question everyone is considering is which model to implement. Since Synthetix has successfully implemented their inflation plan, some propose applying this method to YFI reward distribution.

This proposal received immense support, becoming the foundation for community discussions on inflation, such as DeltaTiger designing the initial Synthetix inflation. Substreight pioneered a new inflation plan model, with a lower issuance rate, while incorporating feedback from community members like yfi_whale, adjusting the long-tail inflation rate to 1%. The next step is to decide which pool to incentivize, with the proposed solution converting the incentives pool to an "80% YFI / 20% yCRV" pool, meeting all three considerations of Andre: incentivizing users, increasing liquidity, and centering governance around holding YFI.

In addition to the proposals under discussion, another mechanism of the initial governance design that people want to change is the current Yearn governance structure, which primarily favors large stablecoin holders rather than YFI holders, who have the long-term interests of the protocol.

The initial design utilized BPT from the "98% yCRV / 2% YFI" pool, creating an imbalance in voting weight, as Andrew Kang pointed out in his proposal, it made it possible for "stablecoin whales to potentially conduct a hostile takeover of governance, where they could propose minting a large number of YFI and disproportionately reward themselves."
Therefore, a temporary voting structure solely by YFI holders was established for voting, and so far, the results have leaned mostly towards "For" with a voting rate of 99.63% (at the time of writing).

However, this is not the only governance event. A few days after the launch of YFI, as its total value locked exceeded over $100 million, it was realized that Andre had the ability to mint tokens at any time, a feature he intended to hand over to the community later but found himself needing it sooner than expected. Due to understandable community concerns, he transferred control of the governance contract to the community, specifically to 9 community members. Some of these members are well-known figures in the DeFi space, such as Compound's Calvin Liu, while the rest are community members who have been involved in YFI from the beginning. This action means that without a minting function in the short term, no new YFI can be issued, and a time lock prevents any changes for at least 3 days. Multisig holders can set up a minting function, but other governance decisions will follow the current status quo, proposing and voting on-chain.

Why is this so crucial?

YFI has proven that as long as a protocol brings value to users, the market will validate the product. It demonstrates that you don't need a complex tokenomics arrangement to attract holders; instead, you need to build a passionate community through fair distribution, much like the way Bitcoin was introduced.

It is currently the only project where the founding team did not receive tokens or any protocol control, as Andre not only relinquished control of the governance protocol but also completely removed himself from setting up the minting function, delegating this responsibility to 9 multisig holders.

The best-performing projects in the crypto space often have the strongest communities, with typical examples being Chainlink and Synthetix. Community members are often the driving force behind discussions, development, adoption, and the resulting network effects.

While it is too early to determine the outcome, by handing over control of the entire protocol to YFI holders, it has ignited the flame of the community.

Risks

Clearly, with liquidity mining offering such high returns and Andre being known for daring tests on live networks or mainnets, people should consider the risks involved.

Risks include:

Potential for failure. Andre mainly uses Synthetix contracts, which have been audited, but the YFI staking contract has not.
Monetary policy risk. If governors pass a plan unfavorable to inflation, it could lead to a loss of platform liquidity, causing a ripple effect across the entire ecosystem.
Human risk. Since Andre did not receive any team rewards or incentives, he may ultimately decide to stop developing the protocol, leading to the ecosystem losing its key figure.

Conclusion

As the distribution of YFI nears its end, economic alliances and governance discussions have fostered high-quality community feedback, making Yearn.finance the most intriguing release to date. The initial success of YFI has given Andre Cronje a platform to realize his DeFi vision.

By aggregating functionalities from various protocols and leveraging the key concept of composability, Yearn has created a product ecosystem that redefines the concept of "money." Now, people can earn interest, mine BAL, CRV (yet to be released), and YFI tokens by holding YCRV (Yearn pool token), as well as participate in governance. This is just the beginning, as Andre continues to build on the existing platform to encompass a wider range of DeFi, including trading and leverage.

Disclosure: The author is bullish on YFI and is one of the 9 multisig holders.

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