Yearn Finance is a yield-optimizing protocol that focuses on maximizing defi profits by automatically switching between defi protocols. What this means as a consumer is that deposits on Yearn finance will be regularly refinanced using an automated process in order to generate maximum return for lenders.
The rise of DEFI has created an investment vehicle called yield farming, where investors constantly move their cryptocurrency between different protocols to generate the maximum return at any given time. Protocols like Compound, Aave, Dy/Dx, and Fulcrum offered investors a percentage of the total return for providing liquidity on their protocols. Yield farming requires time-intensive research daily to identify which protocol has the highest return rate and manually move your investments between DEFI protocols.
In early 2020, Andre Cronje, founder of Yearn Finance, had developed a successful strategy for yield farming using stablecoins. Andre Cronje decided he would use computer code to automate his strategy, remove the need for manual and time-intensive research, and create the first version of the Yearn Finance protocol, automatically identifying and acting on the best strategy available.
After completing the initial version of the protocol, Andre started to invite other users interested in automating their yield strategies to deposit their stable coins into the Yearn Finance protocol.
As the pool of stable coins in Yearn Finance has grown, some of the early strategies that worked for Andre have stopped working efficiently for a larger pool. Because a larger pool has a more significant impact, the Yearn protocol must anticipate what will happen to the pool’s return if a large amount of funds are moved from one protocol to another. The Yearn protocol strategy is constantly adapting to maintain the best rate of return as the size of deposits grows.
The Yearn Finance protocol accepts stable coins and deposits them into the defi protocols, which will return the highest yield. When you deposit a stable coin into Yearn Finance, it is grouped into a pool of the same stable coins. You will receive Yearn Finance Tokens equal to the stablecoin deposited. For example, if you were to deposit USDC, the protocol will issue you yUSDC. The USDC pooled together can be moved between different lending protocols always to maximize the yield. For instance, if Curve offers a better yield than Compound, the Yearn Protocol can transfer all or some of the USDC to Curve.
The protocol checks if there is a better yield available when a user deposits or withdraws money from the pool. Triggering a rebalance of the pool if necessary. When you decide to withdraw your initial USDC, the user can redeem their yUSDC and receive the underlying USDC plus the interest they earned.
Though the Yearn Finance protocol can swap its deposits between different DEFI protocols, it can not swap the initial stablecoin deposit to a different stablecoin, even if there is a higher yield available. This eliminates exchange rate risk or the risk that the Protocol does not have a sufficient supply of a given stable coin, such as USDC, when you decide to withdraw your deposit.
Yearn Vaults offer a way to select how your deposits are managed for users who want to take advantage of specific strategies. Yearn Vaults are pools of funds with an associated strategy for maximizing returns on the underlying asset in the vault. Unlike the default Yearn Finance Protocol, Yearn Vault strategies go beyond just lending out coins. Most vault strategies can do multiple things to maximize the returns, and examples include farming other tokens and selling them for profit, providing liquidity, or borrowing stable coins. Each vault follows a strategy voted on by the Yearn community.
The Vaults differentiate between “vault holdings” and “strategy holdings.” Not all the funds in the vault are put into a strategy. Most of the funds are used in an active strategy, and there can be idle amounts sit in the vault in order to provide liquidity for withdrawals.
When a user withdraws from the vault, the funds first come from the idle portion of the vault, and there is no withdrawal fee charged. If there are not enough funds in the idle part of the vault to cover the withdrawal, the funds have to come from the strategy portion of the vault. This results in a 0.5% withdrawal fee which is used to cover costs moving funds that are tied up in the vault strategy and exchanging them to your deposited token type if required.
Some of the profit-earning strategies result in a 5% fee to subsidize the gas cost. 10% of the fees collected go to the strategy creator. The fees which do not go to the strategy creator end up in a dedicated treasury smart contract. Treasury smart contracts can hold a maximum of 500 thousand dollars. If the maximum threshold is met, the rest of the funds are redirected to a governance staking contract.
In addition to tokens represent deposits such as yUSDC, Yearn Finance also has a Governance token, YFI. A governance token entitles the holder to vote on community issues in order to guide the project, similar to stocks in a company. Andre Cronje decided to create a governance token to promote decentralization of the Yearn Finance protocol and encourage users to participate in making meaningful decisions relating to the future of the protocol.
There are only 30,000 minted and fully distributed. More tokens can only be minted if the community of YFI holders passes a proposal to do so. The initial 30,000 tokens were distributed to users of the protocol using a fair launch. This means that no tokens were pre-mined for insiders, there was no allocation for venture capital and no team reward. All tokens were distributed evenly and fairly to the users of the protocol.
If you own YFI, you can stake your tokens to earn rewards. Administration fees collected throughout the Yearn Finance protocol are paid out to YFI holders who stake their tokens similar to dividends paid out to shareholders. YFI Tokens must be staked to participate in governance.
Anyone who owns and stakes YFI governance tokens can participate in the control of the Yearn Finance ecosystem. Participants can submit and vote on proposals that govern the ecosystem. When a proposal is made, it is voted on by participating YFI holders. For a proposal to pass, voter turnout must be greater than 20% of the number of YFI currently staked. A proposal must also receive a majority vote to pass. If you were to assume that all 30,000 YFI are staked, this means that a minimum of 6,000 tokens (30,000 x 20%) must vote for a proposal to pass, with more than half this amount voting in favour.
Once a proposal passes, it is implemented by a nine-member multi-signature wallet that has the authority to carry out day-to-day implementation and operations. Changes must be signed by 6 out of the nine wallet signers in order to be implemented. Members of the multi-signature wallet are voted in by YFI holders and are subject to change by future governance votes.
Yearn finance was one of the first protocols that automated yield farming. This makes yield farming both easy and accessible to a broader user base. By depositing in Yearn Finance, you can generate high returns previously reserved for active investors with the ease of a passive investment strategy. This was a revolutionary change and one that many other protocols have copied. Despite the increase in competition, Yearn finance remains relevant, and automated yield farming strategies continue to generate returns for stable coin deposits and governance tokens alike.