It’s still very early days in Solana DeFi but there’s already quite a few ways to earn a yield with varying mechanisms and risk profiles. It’s usually a good idea to understand what the risks are since usually, the higher the APYs, the higher the risk. Let’s have a look at what’s available:
Liquidation yield
Yield generation mechanism: Collecting incentives for liquidating risky positions
Risk: Exposure to value of liquidated asset
Examples: Hedge (us!)
When users take margin, a protocol will need to liquidate them when their collateral is no longer within margin requirements (e.g. for Hedge we require a minimum collateral ratio). Hedge offers an pool of our stablecoin, USDH, that collects a yield by liquidating risky vaults and being reward in SOL. Users in this pool are essentially buying SOL at below market price which is how their yield is generated.
Liquidity Provision
Yield generation mechanism: Volume of swaps & fees
Risk: Exposure to value of underlying assets (Impermanent Loss)
Examples: Solfarm(now Tulip), Raydium
This is a pretty common way to earn a yield in DeFi which involves supplying 2 (or more) tokens to a liquidity pool and collecting the exchange fees.
On Solana one can actually increase their exposure to swap volume via leveraged yield farming on Tulip, which allows you to borrow more capital to capture more fees. However you are now exposed to the risk of liquidation since you must make more in fees than the interest rate of the assets you borrowed. You also need to be sure the price of your two assets doesn’t diverge too much (more details here)
Lending
Yield generation mechanism: Interest earned by lending out singled sided asset. Rate usually determined by utilization of asset.
Risk: Exposure to value of underlying assets (Impermanent Loss)
Examples: Jet Protocol, Solfarm(now Tulip)
Lending will usually net you a lower APR than providing liquidity but without the risk of impermanent loss and if the protocol you are lending with has an efficient liquidation system, you can be pretty sure you will actually collect the advertised APR. Most protocols use variable interest so you may want to move your tokens around to ensure they are always earning optimal interest if you notice it drop.
Staking
Yield generation mechanism: Interest earned by securing a network
Risk: Asset being staked falls in value, smart contract breach
Examples: Marinade Finance, Lido Finance, Phantom staking
In a Proof-of-Stake blockchain, validators must lock up some capital while they validate network transactions. If they do they job successfully, they are rewarded with some extra interest but if they fail to validate transactions (either maliciously or due to downtime) their locked up tokens are at risk. On SOL, you can delegate your tokens to a validator that will take a small cut of the rewards in exchange for running a node. More about SOL staking
Token rewards
Yield generation mechanism: Tokens rewarded by a protocol for participating (e.g. providing liquidity)
Risk: Bad tokenomics leading to worthless token, rug and pull scheme
Examples: Raydium Farms
To incentivize users to use a protocol early on and create liquidity, protocols will usually dispense their tokens to early users. Users are thus taking a bet that the tokens will increase in value long term.
Unfortunately since this creates inflationary pressure on the token, it is pretty common for the price to crash so early users are hoping to collect enough tokens to make up this difference.
A solution to this would include a bonding solution, similar to Tokemak or Olympus Pro though no such systems exist on Solana yet. More in depth exploration by Messari.
Protocol fees
Yield generation mechanism: Protocol fees distributed to token holders
Risk: Token inflation & price, performance of protocol
Examples: Raydium Staking
To ensure a protocol’s token maintains a price correlated to its performance, protocols will usually distribute revenue to token holders. Token value is usually also subject to speculation and other market forces since tokens can be used for governance.
Some protocols will straight up distribute revenue to holders staking the token, whereas others will buy more of their tokens using their profits to increase the price of the token.
There are many other ways to earn yield in DeFi though the ones we know of that aren’t available on Solana include:
- Arbitrage pools: A good example on ETH is stabilize.finance which allows to earn a yield by arbitraging between assets that should have the same price
- Selling Put/Calls: A good example on ETH is ribbon.finance and stakedao.org that sell weekly put/call options to collect a premium
- Selling insurance: Examples include Nexus Mutual or Unslashed Finance which allow you to sell insurance to other DeFi protocols
- Anonymity mining: Examples include Tornado Cash on ETH which incentivize users to deposit assets to increase the anonymity of transactions (more details here)
The Hedge team is very excited to introduce liquidation yield pools and we’re looking forward to see more yield mechanisms come to Solana!
