There is an obsession passing through crypto over ‘yield farming’. I have very little idea what yield farming is. In order to learn what it is I am going to look into a coin that recently launched that I saw people tweeting about called Kimchi. I chose this coin as it came out the same day that I made my first batch of kimchi. This post will be a log of my trying to understand this coin.
First, I need to figure out what is yield farming. As far as I can tell yield farming works by placing your token into a Uniswap (or similar auto market maker) contract that is against a dollar equivalent (often Tether or USDC). In order to understand the impact of this I have to zoom out again and refresh my memory of how Uniswap pools work.
[Aside I learned while researching this: Tether and Binance violate the ERC-20 standard by not returning an integer boolean when transfer() is called and both instead return nothing.]
Each pool consists of two ‘ERC-20’ tokens (as discussed above they do accommodate some non standard implementations) (this also means that the contract does not natively handle Eth and instead must use WEth which is ether wrapped in an ERC-20 compliant token). When you make a swap in this pool the token you transfer is exchanged for the proportional value of the other token in the pool. Say there is 1 Eth in the pool and 100 USDC and you swap 0.05 Eth then you will receive 4.747 USDC. This amount may seem odd at first glance, but Uniswap charges a 0.3% fee on the trade which is paid out to those who have contributed their assets to the pool. (Note: this examples ignore gas fees)
So now we need to zoom out slightly more and focus in on the liquidity providers. The way these pools work is that you deposit your tokens to the contract as a liquidity provider and then are paid a liquidity token which represents your proportional ownership of the fees for that contract. This token can be transferred, traded, and lent (this is where some of the more complex interactions come into play) and to receive your payout of the liquidity fee your liquidity token must be burned. On contracts with decent volume you can receive meaningful returns from contributing your tokens to the contract and thus people are incentivized to contribute to further liquidity.
Okay now I feel like I have a strong enough understanding of these systems to actually look at the token in question Kimchi. In the past when assessing new contracts my instinct has always been to read the whitepaper, however Kimchi and many other of the ‘new’ tokens do not have whitepapers. So that stymied somewhat, however Kimchi does tell us it was forked from Sushi and Yuno. I was optimistic that one of these would have a whitepaper. They do not. Sushi however does have a Medium post. Perhaps that will help us understand their system.
The first change is that the liquidity token provided in Uniswap is replaced with a Sushi token that gives an ONGOING right to fees deposited into the contract. I emphasized that in case any securities lawyers come across this article. The way this works is that the majority of the liquidity fee is distributed to active liquidity providers in the same way that it is with Uniswap, but a small portion of it (1/6) is converted to Sushi and issued proportionally to Sushi stakers. Every block Sushi are minted and 90% are distributed to Sushi stakers and the remainder go to the ‘Dev Fund’.
Now we can shift back to Kimchi and try to figure out how it differs from Sushi. First, they mint more tokens in each block. Second, they offer preferential rewards for some pairs. Looking around on Twitter it appears that YUNO the other token they forked from had a backdoor, and Kimchi preserved that backdoor but made it impossible to exploit by tying it to a non-functional contract. https://twitter.com/emilianobonassi/status/1300925536747876354
This also means that there is no real governance or changes that can happen with Kimchi, whereas Sushi claims to be working on governance.
Now we need to zoom out one more time and look at yield farming as a whole and why these tokens are popping up in the first place. Many different DeFi products like Compound issue governance tokens to users and this has incentivized a large amount of liquidity to flow into them. Furthermore, there are people who will contribute their token to liquidity on Compound, and then use the resulting token representing their lent token on Compound as liquidity on Uniswap (or Sushi or whatever). The ability for the same collateral to be used in multiple places, and producing yields in multiple places that can then also be used to generate yield seems to be the basis of yield farming.
My fundamental and deep seated issue with all of this is that this all seems to be happening with such speed that any kind of due diligence is skipped. There are no whitepapers. There are no security audits. There is no community due diligence before money starts pouring in. Many of these contracts have admin keys that allow for the creators to mint a large amount of tokens, to remove liquidity, to change the contract in other ways. This does not seem to be the future of money, but instead a mad cash grab built with the assumption that the black swan will never happen. That the stacked yields won’t eventually succumb to abnormally large withdrawals, or exploits, or extraordinary market conditions. Inevitably they will. I hope every single person with funds committed to them are fully aware of that risk.
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Originally published at http://bennettftomlin.com on September 3, 2020.