Imperial College DeFi Research Paper: An Insight into Revenue Aggregators

Where exactly do these revenue aggregators get their revenue from?

This paper summarizes the paper “SoK: Yield Aggregators in DeFi”, which is the result of joint research between the University College London Blockchain Data Centre (UCL CBT) and Imperial College London.

Yield farming has been a very popular activity for cryptocurrency holders since the explosion of decentralized finance (DeFi) in the summer of 2020.

As of May 2021, asset management agreements in DeFi have locked up over $3 billion, reaching nearly $2 billion locked up at the time of writing.

While there are many (scam) programs that promise users huge gains in a short period of time, income aggregation programs such as Idle Finance, Pickle Finance, Harvest Finance, and Yearn Finance are trying to build a sustainable income stream for the DeFi community. This led me to wonder.

Where exactly does revenue come from?

How much revenue do aggregators get from the Lego they build with money?

What is the general mechanism behind all these aggregators (if any)?

What are the benefits and risks of putting your money into a revenue aggregator?

I co-authored a paper on Yield Aggregators in DeFi with Jiahua Xu from the Blockchain Technology Centre at University College London and Toshiko Matsui from Imperial College London, and this my paper answers all the questions raised above. We propose a generalized framework of yield aggregators. Now let’s dive into the most profitable part of DeFi, namely Yield Farming.

Introduction
As you read in my previous article on Automated Market Makers (AMM), DeFi has seen explosive growth since the summer of 2020.Yield Farming is one of the most talked about applications in DeFi. The concept was originally introduced by Synthetix, but gained wider attention with the release and distribution of Compound’s governance token, COMP.

Since then, Compound participants have been rewarded with newly minted COMP tokens through lending activities, a process that came to be known as “liquidity mining”.

Yield Farming was created in the context of this process, which is still replicated today by other projects that encourage developers to find a way to combine rewards from different protocols. In this context, the aggregation protocol built on top of DeFi’s existing programs is trying to provide a one-stop solution for people who want to do Yield Farming.

Where do the benefits come from?
There is no such thing as a free lunch, so where does the revenue from these revenue aggregators come from? It seems to have three main sources.

Demand for Lending
As demand for crypto-asset loans grows, lending rates will rise, leading to higher returns for lenders. Especially in a bull market, speculators are willing to borrow money despite high interest rates because they expect assets that are long using leverage to appreciate. annualized returns on Aave and Compound’s stablecoins reached 10% in April 2021, when market sentiment was very optimistic.

Liquidity Mining Projects
Early stage participants often receive governance tokens representing ownership of the protocol. This incentivizes people to put money into the protocol, as the reward tokens often have an additional governance feature. This feature is often considered valuable because token holders will have a say in the future strategic direction of the project. Essentially, early adopters are rewarded for helping the project grow and taking on the risks that can occur in the early stages of a smart contract. sushiswap and Finance Finance are examples of this.

Revenue sharing
Some tokens empower users to receive a portion of the revenue earned through the agreement. An example is the Liquidity Provider (LP) token in automated market makers (about which you can read more here). The more people that make trades, the higher the return for the liquidity provider. Another revenue share token is the xSUSHI. holders of the Sushi token will receive xSUSHI in return, which will give them 0.05% of the revenue from trading the Sushiswap protocol. the Vesper Finance governance token, VSP, can be included in the vVSP pool, which captures about 95% of the fees generated by Vesper.

The mechanism behind the revenue aggregation strategy
Now that we know where the aggregator’s revenue comes from, how do users earn revenue through the revenue aggregator? Let’s take a hypothetical yield aggregator “SimpleYield” as an example to explain the following diagram.

Imperial College DeFi Research Paper: An Insight into Revenue Aggregators

Mechanism of the revenue aggregator

In Stage 0, funds are placed in a smart contract. Although newer protocols allow for multi-asset pools to emerge, typically a pool contains only one asset.

Users deposit assets into a pool and in return they receive tokens representing their share of the value in the pool. Example: Deposit # ETH into the SimpleYiel dETH pool and receive back #syETH tokens representing x% of the total value of the pool’s locked positions.

In Stage 1, the funds in the pool are used as collateral to borrow another asset through a lending platform such as Compound, Aave or Maker. This stage is not always necessary and can be skipped. The primary use of this step is to allow a Yield Farming strategy to be executed using another asset (rather than the initial pooled asset). For example, ETH topped up by a user in the SimpleYield ETH pool can be placed in the Maker, thus borrowing the stablecoin DAI.

Phase 2 contains the revenue generation strategy, which can vary greatly in complexity from protocol to protocol. The diagram below shows that the input to this stage is either an asset that does not attempt to generate revenue (red coins) or an asset that generates revenue (green coins). Over time, the green coins generate returns and grow. For example, the SimpleYield ETH pool uses ETH to borrow DAI and now uses that DAI for Compound, where the aggregator earns revenue through cDAI tokens and COMP tokens as part of the Compound liquidity mining program.

Imperial College DeFi Research Paper: An Insight into Revenue Aggregators

The execution process of a single strategy. sc denotes a smart contract

In the final stage, stage 3, the proceeds generated in stage 2 are sold on the open market to the original pool’s assets and flow back to stage 0, where they are redeployed in stages 1 and 2. The pool increases the value of existing shares without issuing new shares. For example, the COMP tokens generated in stage 2 are sold for ETH back at Uniswap and then flow back to stage 0. The #syETH tokens initially generated by the user now have more value because the value of the pool has increased without generating new syETH tokens.

Strategy demonstration
Now that we have an idea of how revenue aggregators typically work, the main point of the protocol is in the second phase, where the revenue is actually generated. Let’s look at some examples of Yield Farming strategies. Note that the examples described here are relatively simple, while these strategies may be much more complex in reality.

The evolution of the pool value is simulated in a controlled market environment. Simulation results are given in this paper.

Simple borrowing and lending
The example used in the previous section is a simple lending strategy. As part of a liquidity mining project, funds are deposited into a loanable funds (PLF) protocol to earn interest and governance tokens.

Revolving Loans
This strategy aims to maximize the amount of governance tokens obtained by the liquidity mining program by borrowing on a revolving basis. Aggregators can deposit DAI into the lendable funds, use that deposit to borrow more DAI, and make that DAI available to the lendable funds again. This cycle can be repeated many times, but simulations based on supply and interest rates show that this strategy can become very dangerous when borrowing too many times in a cycle.

Liquidity Mining with Automated Market Maker LP Tokens
Automated Market Maker (AMM) LP tokens are profitable because the transaction fees are retained in the Automated Market Maker pool. While the automated market maker is still running the liquidity mining program, users are rewarded with governance tokens in addition to the revenue from transaction fees. This strategy is also considered relatively risky, as unearned losses can eat up significant returns when the price of the underlying asset begins to change.

A comparison of battle-tested return aggregators

Imperial College DeFi Research Paper: An Insight into Revenue Aggregators

Summary of major existing and early production revenue aggregators – May 1 data

Idle Finance
Idle Finance is one of the first yield aggregation protocols, which launched in August 2019. idle currently uses only a simple lending strategy to allocate funds across lendable funds (Compound, Aave, Fulcrum, dYdX and Maker). The protocol has two strategies: “optimal return” and “risk-adjusted”. The first seeks the best rate through the platform mentioned above, while the risk-adjusted strategy takes into account risk factors to further optimize the risk-reward score.

Pickle Finance
Launched in September 2020, Pickle is a protocol that provides returns through two products: Pickle Jars (pJars) and Pickle Farms, a Yield Farming robot that generates returns from users’ funds, and Farm, a liquidity mining pool that allows users to earn PICKLE by staking different types of assets. pJars uses an “automated market maker LP token liquidity mining” strategy. Farmers top up Curve LP tokens or Uniswap/Sushiswap LP tokens, which are used to generate governance tokens through the liquidity mining program.

Harvest Finance
Launched in August 2020, Harvest is a protocol that provides compounded returns through its own FARM liquidity mining program. The protocol has two main strategies: a single asset strategy (including a “simple lending” strategy) and an LP token strategy (including a “liquidity mining with AMM LP tokens” strategy). 30% of the proceeds generated are used to buy back the FARM in the open market and flow to the FARM holder, not the original pool.

Yearn Finance
In July 2020, the world’s largest income aggregator was finally launched. yearn offers a variety of products, the ones considered in this article are Earn and Vaults. the Earn pool uses a “simple lending” strategy, depositing assets into a loanable funds agreement at the highest rate. vaults allow for more complex strategies Vaults allows for more complex strategies.

Imperial College DeFi Research Paper: An Insight into Revenue Aggregators

Total value lock, data from defillama

Benefits and Risks of Income Aggregators
Advantages
Farmers do not need to actively develop their own strategies, but can use workflows invented by other users to shift their investment strategies from active to passive.

Since cross-protocol trading is done through smart contracts, the transfer of funds is done automatically, so users do not need to manually transfer funds between protocols.

Since the funds are centralized in the contract, the number of interactions is reduced and the cost of interaction is lowered so that the cost of GAS is diluted.

Risk
Lending risk is always present when Yield Farming strategies use assets as collateral to borrow other assets, or even when they only provide assets to lendable funding agreements. In the case of high utilization (high borrowing/funding ratios), when many lenders draw lines at the same time, some of them may have to wait for some borrowers to repay their outstanding loans. This is called “liquidity risk”. Liquidation risk” exists when the value of collateral falls below a pre-determined liquidation threshold when funds are borrowed.

Because Yield Farming strategies are often built on a series of Lego blocks, there is portfolio risk. Technical and economic vulnerabilities provide attractive opportunities for malicious hackers to exploit.

The returns of a strategy are usually determined by many factors, and for some strategies this results in erratic annualized returns. Fluctuations in annualized returns caused by unearned losses, low trading activity by automated market makers, or price changes in governance tokens are unattractive to many potential investors.

In Summary
The past year has seen the emergence of a plethora of yield aggregator protocols, each with their own style despite the similar general framework behind them.Idle Finance launched the first version of its product in 2019, which deposits funds into a PLF that offers the best rate at a given time.

Inspired by the Compound liquidity mining program, Yearn Finance expanded on this model in July 2020, inventing a more sophisticated strategy called Vault alongside the release of their Earn product.As more forms of liquidity mining programs emerged, Harvest Finance and Pickle Finance used LP tokens exclusively for Yield Farming late last summer.

Yield aggregators were, and still are, an attractive way to collect yields with DeFi. But how long will this yield last? As we have seen, there are three main sources of yield. While the study of yield sustainability deserves a paper of its own, we can assume that the events from local token distribution gains are relatively short-lived.

Such gains are depleted once the token distribution scheme is completed. While new protocols can flourish with newly started token distribution schemes, it seems unlikely that the source of such gains will be sustainable. Lending demand may be more sustainable in this regard, but it is highly dependent on market sentiment, especially for those non-stable coins. Revenue-sharing tokens seem to have the most sustainable gains, especially if DeFi is able to maintain its recent growth rates.

Posted by:CoinYuppie,Reprinted with attribution to:https://coinyuppie.com/imperial-college-defi-research-paper-an-insight-into-revenue-aggregators/
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