How do yield farming rewards work? What is inflation? Lets dig into emissions and what they mean!
Have you ever wondered how yield farms are capable of offering such high interest rates? And, why is it that some yield farming tokens struggle to gain traction, while others thrive? Many factors contribute to the strength of a yield farm like Crystl Finance, and it helps to know what they are. In this article, let’s take a look at the concepts of inflation, emissions, and scarcity!
Inflation In The Early Days
We have all seen the crazy high interest rates available on yield farms, especially early on in their lifetime! On launch day, it’s not out of the ordinary to see APRs in the thousands. Providing liquidity for a brand new yield farm token and earning even more of this token can be extremely enticing! After all, who doesn’t want to earn 2%, 3%, or even 5% daily returns on their investment. But how is it that these interest rates are possible?
Well, to simply put it… These interest rates are created out of thin air! The whole idea behind yield farming is that reward tokens are created perpetually! Emission is the term used to describe the act of perpetual token creation. Who is it that receives these perpetually created tokens? Below are two examples found frequently in DeFi:
- Liquidity providers who make it possible to buy or sell the reward token on a DEX.
- Users who choose to lock away their tokens in a smart contract, instead of selling them
In other words, when a yield farm is still young – the reward token only has one use. To reward liquidity providers as well as users who choose to keep their tokens. On Crystl Finance, the CRYSTL-MATIC Mine and the Auto/Manual CRYSTL Pool are perfect examples of #1 and #2.
On a yield farm’s launch day there may be some initial amount of the reward token put onto the market. Normally, users will compete to grab as many of these as they can. Why? Well, because these tokens are quite scarce at that moment in time, and whoever has the majority of these tokens early on will be able to earn the majority of the future rewards! If the only way to obtain more of a yield farm token is by providing liquidity for it, or single-staking it in a smart contract you can be sure they’ll be in high demand!
These types of conditions are exactly what cause yield farm tokens to jump in price to incredibly high values, creating sky high interest rates (APRs) that are calculated based on the inflated token prices available at that time. However, what’s important to understand is that early on, the reward has only one use, and that is to extract direct profit by selling that token. Although reward tokens continue to be created and sold for profits, at some point the buyers begin to run dry. Suddenly, the high prices become unsustainable and the price drops to more reasonable values, along with the interest rates! This is inflation at work.
Think of it like when the Federal Reserve prints more US Dollars! Every new dollar added to circulation incrementally decreases the value of every other dollar in circulation!
In a lot of yield farms, the only way to extract actual fungible earnings from the protocol is to sell off the native token! Sure, this is great for the user if they can get out at the right time, but not so good for the overall health of the protocol. Rapid emissions and increasing sell pressure have a snowball effect, effectively dropping the price of a yield farm’s reward token.
Tackling Inflation
There are many ways that yield farms attempt to tackle inflation. Usually it comes more as a sum of parts than one easy-fix solution. For example, many projects opt for setting a maximum supply – only running emissions until a certain amount of tokens are in circulation. Or, they lock or vest the rewards to allow the token to build value before it can be sold on the market. These are just some mechanics to mention, and they all come with their own set of advantages and disadvantages.
At Crystl Finance, we have taken three core measures to tackle the problem of inflation:
- Implemented a soft-cap of 12.5M tokens for $CRYSTL.
- Introduced utility for $CRYSTL holders through dividends on the Pools page.
- Introduced auto-compounding Vaults which buyback $CRYSTL from the market and burn it to offset emissions.
Firstly, the native $CRYSTL token does not have a maximum supply cap. Instead, we chose to go with a soft-cap which is achieved by reducing emissions at certain milestones of the circulating supply. A soft-cap essentially allows us to continue rewarding liquidity providers for our partner’s tokens on the Mines, while ensuring that emissions are reduced gradually and do not lead to hyperinflation. You can read more about the soft-cap here.
Secondly, let’s throw away the misconception that the only use-case for a yield farm token is to sell it at market price. At Crystl Finance, we have introduced a wonderful dividends page only accessible to $CRYSTL holders. In other words, users that choose to keep their $CRYSTL reward tokens instead of selling them on the market are instead given the opportunity to continue earning high interest rates by depositing their $CRYSTL on the Pools. This turns $CRYSTL into an incredibly powerful tool that allows users to generate a passive income on their rewards, without having to part with them.
By having this utility for $CRYSTL, we have introduced a strong reason for users not to part with their rewards. Rather than selling them, shareholders of the Crystl Finance protocol which possess the $CRYSTL token have the exclusive right to earn from the deals Crystl Finance establishes with partner projects. Users can utilize $CRYSTL to earn tokens from some of the best projects on Polygon. These tokens are provided by our partners in return for having their token liquidity listed on the Mines with $CRYSTL incentive rewards. A win-win for both the partners who want to build deeper liquidity, and Crystl Finance which wishes to offer the best exposure & high interest rates for its $CRYSTL holders.
Third, at Crystl Finance, we have introduced a supplementary measure to combat inflation. We have created and will continue to add multiple yield optimization protocols which auto-compound earnings from other yield farms into liquidity provider tokens. Users enjoy these Vaults to earn exponential interest, all while contributing a small performance fee which is used to buy $CRYSTL at market price hundreds of times a day and burn it out of existence. You can read about our Vaults here.
How Are Emissions Related To APR?
There seems to be a lot of confusion in DeFi regarding how APR metrics are calculated. In fact, many users express frustration when interest rates don’t provide the advertised interest rates. What’s important to remember is this: APR is a snapshot. It is more of an estimation, than an exact figure.
When you view the APR of a given Pool or Mine, the calculated result is made from all the current market conditions, which include, but are not limited to:
- The price of the assets being staked (in the case of a Mine, the value of the LP tokens)
- The value of the reward token (in this case, the value of $CRYSTL)
- The existing number of assets being staked in the Mine, and the available emissions being used to reward the providers of these assets in a proportional manner
Consider the example below:
Here, the two Mines of AZUKI-MATIC and BANANA-ETH have a similar allocation of yield farming reward emissions (7x and 6x are pretty close). Both Mines are emitting $CRYSTL rewards and rewarding the liquidity providers staking LP tokens in these options. But, notice that AZUKI-MATIC is rewarding an astounding 201.56% APR, while the BANANA-ETH pair only rewards 28.96%.
The reason for this is simple, take a look at the liquidity in the AZUKI-MATIC, at $76,751 and compare that to the other one at $457,915. Clearly the BANANA-ETH pair has much more liquidity than the AZUKI-MATIC, and thus, the $CRYSTL rewards that are always being minted and distributed to the BANANA-ETH Mine are distributed evenly across all the liquidity providers. Since there are more providers, each one has to make due with a little less $CRYSTL – resulting in the lower apr of 28.96%.
Understanding this is critical; If the staked token goes up in value, the apparent APR decreases. In other words, if the value of BANANA-ETH went up in value further, then the APR would drop! But in reality, the Mine is still receiving the same number of $CRYSTL emissions overall! In this sense, APR can sometimes be a misleading metric that is easy to misinterpret.
Making $CRYSTL Scarcer By Reducing Emissions
As emissions reduce, this is going to decrease the amount of $CRYSTL that is allocated as rewards to those contributing liquidity in Mines. Of course, this leads to a decrease in rewards (and thus APR). But, on the other hand, this increases scarcity! With every reduction, the amount of $CRYSTL entering existence is less! This likely won’t have an immediate effect, but in the long run reducing emissions with our soft-cap emission structure creates favorable conditions in which the scarcity of $CRYSTL is increased which can be expected to lead to a price increase over time as well.
If one considers the increase in scarcity, as there is now considerably less $CRYSTL being emitted by the contract, it means that it’s that much easier to buy $CRYSTL on the open market than it would be to farm it, which leads to price increasing, stabilizing rewards again!
How Do Pool Rewards Work?
Pool rewards are another confusing concept for some users. However, they operate in a really simple fashion! Imagine it exactly as it sounds, a Pool of tokens. The pool, over a predetermined amount of time, emits a reward to you based on the amount of $CRYSTL you have staked in the pool in relation to everyone else! It’s beautifully simple. For example, if the Pool is set to deliver 100 tokens a day – these 100 tokens will be proportionally split between the users currently depositing their $CRYSTL in the Pool contract, based on their position compared to the total $CRYSTL staked in the Pool.
Now, how do tokenomics affect pool APRs? If you’ve got an understanding of how APR is calculated, one can see what might happen. As emissions are reduced, the supply of $CRYSTL will reduce. As more use-cases are implemented for $CRYSTL (more pools, NFTs, governance, more Vaults with buybacks & burns etc), this will cause the demand to increase. More demand, coupled with a reduced supply, means that the price increases rather meaningfully! That’s great for your $CRYSTL bag!
As $CRYSTL’s price increases, what can be observed is that the APR metric across the Pools will decrease, because although the value of the staked asset becomes higher – the reward emissions on the Pools remains the same. If the number of $CRYSTL deposited in a Pool remains the same, and the price goes up, the APR may go down but in reality the active stakers of the Pool are still earning the same number of tokens as they did previously. What’s great about this is that regardless of the price of $CRYSTL going up or down, the Pools are always giving out consistent rewards!
Staking Pool rewards are calculated without paying attention to the price of $CRYSTL, meaning the more $CRYSTL you have, the more tokens will be allocated to you, and has nothing to do with the $USD value of $CRYSTL.
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