Most people who have been involved with cryptocurrencies in any way over the past few years are aware that there are many projects out there these days that are offering amazing annual percentage returns (APYs).
As a matter of fact, Many decentralized finance (DeFi) protocols built using the Proof-of-Stake (PoS) consensus protocol offer their investors ridiculous returns in exchange for staking their native tokens.
However, like most deals that sound too good to be true, many of these deals are cash grab programs, at least that’s what the vast majority of pundits say. For example, YieldZard, a project positioning itself as a company focused on DeFi innovation with a self-seizure protocol, claims to offer its customers a fixed annual rate of 918.757%.. Put simply, if one invested $1,000 in the project, the cumulative return would be $9,187,570, a number that would seem cloudy to even the average eye, to say the least.
YieldZard is not the first project of this kind as the offering is a mere imitation of Titano, one of the first auto-staking tokens that offered fast and high payouts.
Are these returns really achievable?
To get a better idea of whether these seemingly ridiculous returns are actually feasible over the long term, Cointelegraph contacted Kia Mosayeri, chief product officer at Balancer Labs, an automated DeFi market-making protocol that uses novel self-weighted pools. In her opinion:
â€œSophisticated investors will want to look at the source of the return, its sustainability and capacity. A return driven by strong economic value, such as B. Interest payments on debt or percentage fees paid for trading would be far more sustainable and scalable than a return derived from random token issuance.
Ran Hammer, vice president of business development for public blockchain infrastructure at Orbs, offers a more holistic view of the matter, telling Cointelegraph: Aside from the ability to enable decentralized financial services, the DeFi protocols introduced another major innovation to the cryptocurrency ecosystem: the ability to generate returns on more or less passive holding.
He further explained that not all returns are inherently equal, as some returns come from “real” income while others are the result of high issuance based on tokenomics-like economies. With that in mind, it is very important to understand where performance comes from when users act as lenders, stakers or liquidity providers. For example himTransaction fees for processing power, trading fees for liquidity, a premium for options or insurance, and interest on loans are all “true returns.”
Nevertheless, Hammer explained that most incentive-based protocol rewards are funded by token inflation and may not be sustainable as there is no real economic value funding these rewards. The concept is similar to Ponzi schemes, which require an increasing number of new buyers to keep the token economy valid. He added:
â€œDifferent protocols calculate emissions using different methods. It’s much more important to understand where the return is coming from when you factor in inflation. Many projects use premium spending to create a healthy distribution of holders and drive an otherwise healthy token economy, but higher fees need more scrutiny.”
Lior Yaffe, co-founder and director of blockchain software company Jelurida, shared a similar sentiment to Cointelegraph The idea behind most high yield projects is that they promise high rewards to players by collecting very high commissions from traders on a decentralized exchange and/or constantly minting more tokens to pay the returns to your players
This ploy, Yaffe noted, can work as long as there are enough new buyers, which really depends on the team’s marketing skills. At some point, however, there isn’t enough demand for the token, so minting more coins will quickly deplete its value. “At this point, the founders usually leave the project, only to reappear with a similar token at some point in the future,” he says.
High APYs are fine, but they can only go so far
Narek Gevorgyan, CEO of DeFi wallet and cryptocurrency portfolio management app CoinStats, told Cointelegraph that billions of dollars are stolen from investors every year mainly because they fall for these types of high APR traps, adding:
â€œI mean, it is pretty obvious that there is no way projects can offer such high APYs for long periods of time. I have seen many projects with unrealistic interest rates, some well over 100% APY and others as low as 1,000% APY. Investors see big numbers, but often overlook the loopholes and risks that come with them.
He explained that investors must first realize that most returns are paid in cryptocurrencies, and since most cryptocurrencies are volatile, assets lent for such unrealistic APYs can depreciate over time, resulting in significant temporary losses can.
Gevorgyan further noted that in some cases If a person is using their cryptocurrencies and the blockchain is using an inflation model, it is fine to receive APY, but when it comes to really high returns, investors need to be very careful and adds:
â€œThere is a limit to what a project can offer its investors. These high numbers are a dangerous combination of insanity and arrogance because even if you offer a high APY should it decrease over time, this is basic economics because it becomes a question of project survival.”
And while he admitted that there are some projects that can offer comparatively higher returns on a stable basis, Any offer that advertises high, fixed APYs for long periods of time should be viewed with a high degree of suspicion. “Again, not all are scams, but projects that claim to offer high APYs without transparent proof of how they work should be avoided.”said.
Not everyone agrees, well almost
0xUsagi, the leader of the pseudonymous protocol Thetanuts — a crypto derivatives trading platform that boasts high organic returns — told Cointelegraph that different approaches can be used to generate high APYs. He explained that token returns are generally calculated by distributing tokens pro rata to users based on the amount of liquidity deployed in the project being tracked for an epoch, adding:
“It would be unfair to call this mechanism a scam as it should be viewed more as a customer acquisition tool. It is usually used at the start of the project to quickly obtain liquidity and is not sustainable in the long term.”
Provide a technical breakdown of the matter, 0xUsagi found that whenever a project’s development team posts high token yields, liquidity floods the project; However, when it is depleted, the challenge becomes liquidity retention.Â
In this case, two types of users are created: The former going in search of other “farms” to get high returns and the latter continuing to support the project. “Users can refer to Geist Finance as an example of a project that has achieved high APYs but still retains plenty of liquidity,” he added.
That is, as the market matures, There is a possibility that even legitimate projects The high volatility of cryptocurrency markets can cause returns to decline over time similar to the traditional financial system.
“Users should always assess the level of risk they pose they enter into by participating in a farm. Check community communication channels for code audits, sponsors, and team responsiveness to assess security and performance.” Project pedigree a free world lunch,” concluded 0xUsagi.
Market maturity and investor education are key
Zack Gall, VP of Communications at the EOS Network Foundation, thinks that whenever an investor comes across flashy APRs, they should simply treat them as a marketing gimmick to attract new users. Investors should therefore educate themselves to stay out of it, be realistic or prepare for an early exit strategy if the project implodes. And he added:
“Inflation-driven returns cannot be sustained indefinitely due to the significant dilution that must occur in the underlying stimulus token. Projects need to strike a balance between attracting end users who typically want low fees and incentivizing tokens interested in making the most of it. The only way to sustain both is to have a sizable user base that can generate significant revenue.”
Ajay Dhingra, head of research at Unizen — a smart exchange ecosystem — says that when investing in a high-yield project, investors should educate themselves on how APYs are actually calculated. He found that APY arithmetic is closely tied to the token model of most projects. For example, The vast majority of protocols reserve a significant portion of the total supply – say 20% – just for giving out rewards. Dhingra further noted:
“The key differentiators between scams and legitimate performance platforms are clearly established sources of benefit, whether through arbitrage or lending; Payments in tokens that aren’t just governance tokens (things like Ether, USD Coin, etc.); long-term demonstration of consistency and reliable operation (1 year or more).”
Because of this, As we move into a future powered by DeFi-centric platforms — particularly ones that offer extremely lucrative returns — it is paramount that users do their due diligence and educate themselves on the ins and outs of the project on which they are working they may have to invest work or be at risk of being burned.
Clarification: The information and/or opinions expressed in this article do not necessarily reflect the views or editorial line of Cointelegraph. The information contained herein should not be construed as financial advice or investment recommendation. All investment and trading movements involve risk and it is the responsibility of each person to conduct their proper research before making any investment decision.