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DeFi Scam Prevention | What exactly is Yearn Finance and YFI? yCRV, Vault

2020/9/20

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There have been many articles about FYI founder Andre Cronje, but not much has been explained about what yearn finance is. What is YFI, the coin known as the Bitcoin of the DeFi world? What exactly is yearn finance doing? We will explain it to you through a video from Finematics.

The "DeFi Fraud Prevention Series" aims to help readers understand the operation principles and types of DeFi liquidity pools, to rationally assess the nature and reasons behind these "special" coins, and to be cautious of investment risks.

This article will give you a preliminary understanding of why Andre Cronje created yearn finance, the purpose and evolution of the yearn protocol, as well as the creation and uses of YFI.We recommend readers to watch the video along with the translated content, and refer to the original video for accuracy.

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Origin of the yearn Protocol

The main element of yearn finance is the yearn protocol, which is essentially a "yield optimizer" that maximizes DeFi efficiency by switching between different lending protocols to maximize returns.

To understand how the yearn protocol came about, let's go back to the beginning. In early 2020, the creator of the yearn protocol, Andre Cronje, started developing automated strategies to invest his stablecoins in the highest-yielding lending protocols. Before the initial iteration of this protocol, Andre used to manually check each day which protocol offered the highest annualized return and decide where to move his funds among options like Compound, Aave, Fulcrum, or dydx.

These manual operations were repetitive and tedious, prompting Andre to develop the initial version of the yearn protocol to automate the process of optimizing the strategy selection.

In essence, the protocol creates a pool of funds for each stablecoin, and those who deposit stablecoins receive a y token, which is equivalent in value to the deposited stablecoin plus interest earnings.

For example, if a user deposits DAI stablecoins, the yearn protocol will give them a yDAI token. The deposited DAI will be moved between different protocols to seek the highest annualized returns. If the DAI interest rate on Aave is higher than Compound, the yearn protocol can decide to transfer all or part of the DAI to Aave. The protocol also checks for better rates when users deposit or withdraw funds from the pool, allowing the pool to rebalance when necessary.

If users wish to redeem their funds, they can return the yDAI and receive their principal and interest. The protocol ensures that even if the interest rates for other cryptocurrencies are better, the originally deposited stablecoin will not be swapped for another stablecoin. For example, if a user deposits DAI, the protocol will not exchange it for USDC, even if the USDC interest rate is higher. This is because users want to receive the same cryptocurrency they deposited when redeeming their funds.

After the first version of the protocol was completed, Andre decided to make it available to more users interested in automated strategies. From a protocol perspective, adding more funds is beneficial because more deposits or withdrawals trigger the rebalancing of the pool. Once the protocol gained community acceptance, Andre also focused on improving the protocol.

Partnership with Curve: Introduction of yCRV

As the pool of funds grew larger, early strategies of moving funds to high-yield protocols became ineffective. Therefore, the yearn protocol had to consider the impact on the APY annual return when a large amount of funds was deposited into a specific protocol. Thus, the yearn protocol had to consider how to split funds into different protocols and find the optimal solution.

Simultaneously, Andre began collaborating with Curve to create the yCRV liquidity pool. This pool includes yDAI, yUSDC, yUSDT, and yTUSD, allowing the conversion of y tokens without the need for redemption. By depositing stablecoins into the yCRV pool, users earn fees from the conversion of y tokens due to providing liquidity and receive y tokens with interest earnings. This makes it relatively easy to find the best APY based on a specific stablecoin.

Changes Brought by Liquidity Mining

The emergence of liquidity mining brought dramatic changes, with Compound's governance token COMP being a primary example. COMP's liquidity mining changed the landscape of finding the best interest rates, rendering looking for the best APY ineffective. To determine actual rates, you needed to include all tokens distributed additionally, making finding the best strategy increasingly complex. With the evolution of liquidity mining frenzy, Andre and the yearn community began focusing on another idea – Vaults.

Introduction of Vaults

Vaults, in essence, are pools of funds with different profit maximization strategies. Vault strategies are more proactive than just borrowing funds and can perform various operations to maximize profits, such as participating in liquidity mining, selling tokens for profit, providing liquidity, or borrowing stablecoins. Each strategy within a Vault is decided by the yearn community through voting.

What is YFI?

To decentralize yearn and involve more people in meaningful decision-making for a better future of the protocol, Andre decided to distribute governance tokens to the yearn community, emphasizing fairness and rewarding the community. To ensure fair distribution, the YFI token had no pre-mine, no venture capital allocation, and no team rewards. All tokens were distributed to protocol users.

Over a nine-day distribution period, 10,000 YFI tokens were distributed to liquidity providers (LPs) of the yCRV pool. These LPs had to stake liquidity proof tokens of yCRV to receive YFI rewards. Soon after, two Balancer liquidity pools also joined, each with a quota of 10,000 YFI tokens. In total, there were 30,000 YFI tokens.

Although the statement from yearn indicated that YFI had no inherent value, funds flowed into these liquidity pools, locking up a value of $600 million, and the YFI token price surged rapidly. At the time, the discussed risk was that before decentralized governance was implemented, the protocol's creator still held the admin key, which could potentially be used to create more YFI tokens, leading to a price collapse. This issue was quickly resolved by transferring the single key to a multisig key requiring multiple signatures from the yearn community.

The governance design of the YFI token is meant to decide many future issues regarding yearn. With one of the most active and loyal DeFi communities, many speculate that the YFI token may offer profit-sharing, leading to an increase in token value. Initially priced around $6, the token's price skyrocketed to over $30,000 in less than two months, showing almost exponential growth.

In addition to yearn finance's core components – the yearn protocol and vaults – there are other services like ySwap, yTrade, yBorrow, and yInsure.

yearn is one of the most intriguing protocols in the DeFi space, but like other interesting DeFi projects, it's important to assess related risks before deciding to use a protocol.