#210—Sam Bankman-Fried explains yield farming

Also, what the IMF thinks about DeFi

May 02, 2022

Welcome to Yaka Stuff, our weekly newsletter that covers news, industry perspectives, and updates from the Hard Yaka ecosystem. Check out last week’s report here.

This week:

Sam Bankman-Fried explains yield farming
SBF explains why yield farming isn’t a ponzi scheme (or is it?)
The IMF talked about DeFi, too
Tweet of the week—what happened to Solana?
This week in policy
Ecosystem updates
Stuff happens

1. Sam Bankman-Fried explains yield farming

Sorry, folks–only non-copyrighted photo of Sam I could find. Photo: Wikipedia/Cointelegraph

Two of our favorite people, Matt Levine, author of the Money Stuff newsletter, and FTX’s Sam Bankman-Fried had a chat about DeFi.

During the chat, Matt asks SBF about how yield farming actually works.

Here’s his answer (truncated version):

SBF: Let me give you sort of like a really toy model of it, which I actually think has a surprising amount of legitimacy for what farming could mean. You know, where do you start? You start with a company that builds a box and in practice this box, they probably dress it up to look like a life-changing, you know, world-altering protocol that's gonna replace all the big banks in 38 days or whatever. Maybe for now actually ignore what it does or pretend it does literally nothing. It's just a box. So what this protocol is, it's called ‘Protocol X,’ it's a box, and you take a token. You can take ethereum, you can put it in the box and you take it out of the box. Alright so, you put it into the box and you get like, you know, an IOU for having put it in the box and then you can redeem that IOU back out for the token.
And then you say, alright, well, you’ve got this box and you’ve got X token and the box protocol declares, or maybe votes by on-chain governance, or, you know, something like that, that what they're gonna do is they are going to take half of all the X tokens that were re-minted. Maybe two thirds will, two thirds will offer X tokens, and they're going to give them away for free to whoever uses the box. So anyone who goes, takes some money, puts in the box, each day they're gonna airdrop, you know, 1% of the X token pro rata amongst everyone who's put money in the box. That's for now, what X token does, it gets given away to the box people. And now what happens? Well, X token has some market cap, right? It's probably not zero. Let say it's, you know, a $20 million market …
Matt: Wait, wait, wait, from like first principles, it should be zero, but okay.
SBF: Uh, sure. Okay. Completely reasonable comments.
…
SBF: That's right. So, and obviously already we're sort of hiding some of the magic impact, right? Like some of the magic is in like, how do you get that market cap to start with, but, you know, whatever we're gonna move on from that for a second. So, you know, X tokens [are] being given out each day, all these like sophisticated firms are like, huh, that's interesting. Like if the total amount of money in the box is a hundred million dollars, then it's going to yield $16 million this year in X tokens being given out for it. That's a 16% return. That's pretty good. We'll put a little bit more in, right? And maybe that happens until there are $200 million dollars in the box. So, you know, sophisticated traders and/or people on Crypto Twitter, or other sort of similar parties, go and put $200 million in the box collectively and they start getting these X tokens for it.
And now all of a sudden everyone's like, wow, people just decide to put $200 million in the box. This is a pretty cool box, right? Like this is a valuable box as demonstrated by all the money that people have apparently decided should be in the box. And who are we to say that they're wrong about that? Like, you know, this is, I mean boxes can be great. Look, I love boxes as much as the next guy. And so what happens now? All of a sudden people are kind of recalibrating like, well, $20 million, that's it? Like that market cap for this box? And it's been like 48 hours and it already is $200 million, including from like sophisticated players in it. They're like, come on, that's too low. And they look at these ratios, TVL, total value locked in the box, you know, as a ratio to market cap of the box’s token.
And they’re like ‘10X’ that's insane. 1X is the norm.’ And so then, you know, X token price goes way up. And now it's $130 million market cap token because of, you know, the bullishness of people's usage of the box. And now all of a sudden of course, the smart money's like, oh, wow, this thing's now yielding like 60% a year in X tokens. Of course I'll take my 60% yield, right? So they go and pour another $300 million in the box and you get a psych and then it goes to infinity. And then everyone makes money.
Matt: I think of myself as like a fairly cynical person. And that was so much more cynical than how I would've described farming. You're just like, well, I'm in the Ponzi business and it's pretty good.

2. SBF explains why yield farming isn’t a ponzi scheme (or is it?)

Still from the cynical perspective:

Right. So let me, okay, cool. I'll stay on the cynical route, think about like cynically, what could happen here? Well, okay. So you've got this boxes and it’s kind of dumb, but like what's the end game, right? This box is worth zero obviously. And like that, you know, you can't like keep this smart cap or something. But on the other hand, if everyone kind of now thinks that this box token is worth about a billion dollar market cap, that's what people are pricing it at and sort of has that market cap. Everyone's gonna mark to market. In fact, you can even finance this, right? You put X token in a borrow lending protocol and borrow dollars with it. If you think it's worth like less than two thirds of that, you could even just like put some in there, take the dollars out. Never, you know, give the dollars back. You just get liquidated eventually. And it is sort of like real monetizable stuff in some senses. And you know, at some point if the world never decides that we are wrong about this in like a coordinated way, right? Like you're kind of the guy calling and saying, no, this thing's ac

All of which is to say that what we decide to be money and value has always sort of been a social experiment. It’s a collective agreement.

We decided that gold had value and it has. (For thousands of years.)

The same goes for Bitcoin.

(And you’ll see plenty of Twitter accounts claiming that USD is a ponzi scheme.)

It’s probably not that surprising that DeFi falls into the same bucket. (Both ways.)

Also, check out this piece on ApeCoin and “the death of staking.”

Relevant:

3. The IMF talked about DeFi, too

Here’s Axios:

A new report from the International Monetary Fund found that decentralized finance (DeFi) is... pretty centralized.

Half the money available to be borrowed on most DeFi lending platforms comes from fewer than 10 depositors, IMF researchers reported in April's Global Financial Stability Report.

Why it matters: Crypto products are open so they can be resilient, the theory being openness leads to many participants. But if most funds available for lending come from a few giant depositors, that could cause a one-person bank run.

Check out the IMF’s report:

Global Financial Stability Report | April 2022

4. Tweet of the week—Solana downtime edition

Laine’s tweetstorm on why Solana’s blockchain stopped producing new blocks over the weekend:

Laine | stakewiz.com @laine_sa_

What a weekend. Yesterday the Solana blockchain halted, which means it stopped producing blocks. This resulted in validators coordinating a cluster restart which requires 80% of stake (minimum 605 validators). A 🧵 on what occured. 👇

5. This week in policy

6. Ecosystem updates

/gregkidd participated in the TecXposition conference not long ago and those videos are now available for your viewing pleasure:

Indicio announced their $3.5 million seed round last week:

Indicio, the market leader in developing Trusted Digital Ecosystems to verify and exchange high-value information, announced today that it has raised $3.5 million in a fundraising round led by Hard Yaka. The company has quickly emerged as a market leader in developing decentralized technology to verify data through creating Trusted Digital Ecosystems. Indicio will use the funds to scale market adoption across industry verticals with a continued focus on finance, healthcare, and travel.

Also, if you’re in New York on Tuesday at 7pm ET, stop by Williamsburg for a special event hosted by Origin Trail featuring a fireside chat with internet pioneer Dr. Bob Metcalfe:

Join us for a special fireside chat with one of the Internet pioneers and the founder of Ethernet, Dr Bob Metcalfe, followed by a gift from the OriginTrail founders.
If there’s someone to talk about the future of the Internet, it should be the one who pioneered it. You will hear all about the power of network effects straight from the source, Dr. Bob Metcalfe himself.
Next, we’ll discuss how using the same knowledge graph technology Google used to organize information and blockchain tech powering Bitcoin and other cryptocurrencies, OriginTrail is organizing humanity’s most important web3 assets, making them discoverable, verifiable, and valuable. And then prove it with a bang.
After the presentation and surprise, stick around for a few drinks on the house, DJ vibes, and some serious networking.

Invite link here.

USBC

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