Decoding DeFi Yields: Where Do They Come From?

The world of Decentralized Finance (DeFi) has grown exponentially in recent years, offering users a wide range of yield-bearing instruments to generate passive income. However, with great rewards come great risks. In this article, we will delve into the mechanics behind DeFi yields and explore the sources of profit.

When considering where to invest $100,000 in crypto, DeFi users often face a daunting decision: which instrument offers the highest yield? A lending protocol at 4% per year, a pool yielding 10%, or a vault at 15%? The key to making an informed decision lies in understanding who is paying and what risks are involved.

The Incrypted editorial team examined the sources of DeFi yield and found that they can be broadly categorized into two main areas: lending and providing liquidity in an Automated Market Maker (AMM). In both cases, the user receives a payout from the borrower or trader, respectively. However, as rates on most DeFi instruments are too low relative to potential risks, users must exercise caution.

The rising number of protocol hacks has further exacerbated this issue. As the DeFi sector evolves, the gap between baseline sources of profit and payouts being offered is widening. This necessitates a deeper understanding of yield-bearing tokens, complex strategies, and vaults, which can enable more efficient capital management but also introduce additional risks.