YFI A Tale of Fair Launch, Governance and Value

https://insights.deribit.com/market-research/yfi-a-tale-of-fair-launch-governance-and-value/

Earlier this year, a16z released a blog post titled “Progressive Decentralization: A Playbook for Building Crypto Applications” in where they described three key factors they believed to be key to a project’s success:

  1. Product/market fit
  2. Community participation
  3. Sufficient decentralization (community ownership)

At time of writing in early January, they mentioned they had yet to see a project fully execute on each of those factors sequentially, but Yearn.finance managed to do that over one weekend, accruing well over $400m in AUM with the most active community participation seen yet. DeFi thought leaders and teams from all around banding together and governance was completely handed over to the community.

What is Yearn.Finance or $YFI?

Yearn.finance is what used to be iearn.finance an automated DeFi yield aggregator that had around $8m AUM with ~10.5% aggregate yields before shipping $YFI last Saturday. It works primarily by automatically depositing stablecoins and farming yields from multiple protocols like AAVE, Compound and dYdX. Yearn.finance is a relaunch that brought with it a whole new suite of yield tools such as ytrade, yliquidate, yleverage, ypool and smart contract credit delegation lending.

Fair Launch?

The lead developer behind it, Andre Cronje, decided that he would create a $YFI token, and with that pass over control/governance of the entire yearn.finance suite of tools. Despite having the power to give himself a pre-mine or founder reward, he elected instead to keep zero tokens for himself.

With this, $YFI has had the most favorable supply distribution for a DeFi Community that’s ever been seen with everyone that earned tokens having undertaken the same risks with all the information freely available to them. This fair launch is reminiscent of early Bitcoin mining, as nobody had a head start–not even Andre, and the only way to acquire it was to earn (mine) it. Much like early bitcoin miners, early YFI yield farmers have self-selected as those most in tune with DeFi, ensuring a passionate and involved community..

How do you earn it?

In short, you have to provide liquidity to the ecosystem. The initial supply of 30k YFI was distributed equally into 3 different pools with differing mechanisms, each targeting a different goal.

  1. Actual users of the yearn protocol. All Liquidity Providers on the Curve.fi yearn pool who staked their tokens (yCRV) would earn a portion of 10k depending on their share of the pool over a week.
  2. Liquidity Incentivisation. By providing liquidity on Balancer in portions of 98% DAI and 2% YFI, Liquidity providers would earn a portion of 10k depending on their share of the pool over a week.
  3. Governance Participation. By providing liquidity on Balancer in portions of 98% yCRV and 2% YFI, and then staking the balancer pool tokens (BPTs) would earn not only a portion of 10k depending on their share of the pool over a week, but also allocate voting shares in proportion to the number of BPTs staked. Voting is also a prerequisite for participating in the fee rewards pool, which pays out protocol fees to qualifying stakers of YFI in the rewards contract.

Yearn exploded in usage and AUM shot up to well over $400m in less than a week, a strong indication that it’s achieved Product Market Fit as it would sit around #5 in TVLs across the entire DeFi Ecosystem according to Defipulse.com. However the question still remains on how sticky any of that capital is at the moment as they could just be chasing yields at the moment. Importantly, for this yield to be real, YFI the token itself must have enduring value.

Fair Value?

The question on everyone’s mind with the recent frenzy of governance tokens launching such as Compound, Balancer, BZRX and now YFI, is how do you value governance?
Some have pitched the idea that the project should be worth more or equal to its total value locked (TVL), as you might imagine if it’s cheaper than that it would pose a large security risk to the protocol as someone could make a malicious governance attack to it. Additionally, governance tokens could always vote to receive future cash flows/revenues generated from the company if it makes sense, which would arguably then generate a premium for the token.

In the $YFI token announcement blog post, Andre declared that the Fair Value of the $YFI token is 0, as there was no sale and there will never be one, all tokens will have to be earned. But if applying the TVL = MC theory, YFI was severely undervalued, and coupled with the fact that everyone was drawn in to the very lucrative yields, there was a pseudo-ponzi scenario where people were rushing into to provide liquidity and thus increasing the TVL which itself lead to a positive feedback loop in increasing the prices with it. However, it is worth noting that Yearn’s TVL is actually shared with the other base protocols like AAVE or Curve, so it’s total value locked might be effectively smaller than one might assume.

On top of all that, as mentioned earlier $YFI stakers in Pool 3 were actually eligible for a claim to all fees generated by the system for that week, which amounted to ~$54,288 USD for just the first week. If you annualised that, it would be ~$3m per year which at $1,000 per $YFI would have amounted to having a PE ratio of 10.

Governance and Voting and the power of community

With the launch of $YFI, there also came with it a couple of key proposals, each to be voted by those that have participated in Pool 3.

Proposal 0: Minting $YFI

  1. If “for” wins, proposal #2 will be submitted to set the weekly distribution quota
  2. If “against” wins, no more tokens will be distributed

If Proposal 0 had not passed, there would never be any new $YFI minted and the total supply would have been forever capped at 30k YFI, while this would have been great in achieving scarcity of the token and rewards the early farmers, it would not benefit the new entrants, and thus would ultimately hinder $YFI’s growth. Additionally, existing liquidity providers would no longer have any incentives to continue providing liquidity which would result in a drop in the TVL.

This was met with long debates and discussions from the community, but for a time it looked to be that Proposal 0 was actually going to fail up until the last few hours when it was (31% for and 69% against), until the vote was swung to “for” by the anonymous yfi_whale after a proposal was published. yfi_whale argued that keeping inflation going and by extension, yield farming would serve as a way to attract newcomers from a PR and Marketing perspective at the cost of a small dilution.

The need to maintain an inflationary model was clear enough, but the question on everyone’s mind however was which one to implement. With Synthetix having tried their inflation schedule with much success, a proposal was made to implement that to YFI rewards emissions as well. This proposal was met with great support and served as the basis for inflation discussions with community members like DeltaTiger (who designed the original Synthetix Inflation) and Substreight who took the lead in modelling a new inflation schedule with a much lower issuance and a long tail inflation of 1% adopting comments from community members like yfi_whale. Next was then to decide which pool to incentivise, among the suggested options were to switch the pools to a 80% YFI / 20% yCRV pool would have fulfilled all 3 considerations that Andre had as well, that was to incentivise users, increase liquidity and align governance to more YFI holding centric.

Besides, the proposals that were being discussed, there was another mechanic of the initial governance design that people wanted to change, namely the design that the current yEarn governance mechanism was mostly skewed towards large stablecoin holders rather than YFI holders, who are the ones with the most vested long term interest of the protocol. The original design of using BPT from the 98% yCRV / 2% YFI pool created an imbalance in voting weights and as Andrew Kang put it in his proposal, it allows for the possibility of “a hostile takeover of governance by stablecoin whales who could potentially pass a proposal to mint a large supply of YFI and disproportionately reward themselves”. A Temporary YFI only voting structure was put up for a poll, with the results so far largely towards ‘for’ with 99.63% of votes. (at time of writing)

However this wasn’t the only incident with governance, a couple days from the launch of $YFI, when it reached well over $100m in TVL, some realised that Andre had the ability to mint tokens whenever he wanted to, a function that he originally intended to pass over the community later but he never expected that it would have been needed so soon. But as the community were understandably concerned, he gave up control of the governance contract over to the community, a group of 9 community members, some of whom were well-known personalities in DeFi like Calvin Liu from Compound and Curve but the rest were community members involved in YFI from the beginning. What this means is that , in the immediate short-term, no new YFI can be minted as there is no minter and the time-lock prevents one from being set for a minimum of 3 days. The multisig owners can set minters, but the rest of the governance decisions are to follow the status quo in which a proposal is made and an on-chain vote is carried out.

Why does any of this even matter?

YFI has proven that the market validates products as long as the protocol returns value to users. It proved that you’d didn’t need to come up with a complicated vesting schedule to entice holders, rather a fair distribution to build up a passionate group of community members who are familiar already with the protocol, much like how Bitcoin’s launch was.This is the only project in recent times where the team has had 0 tokens allocated to it nor do they have any control over the protocol with Andre not only relinquishing control over the governance contract, but removing himself entirely from the minter set by passing that responsibility to the 9 multisig holders.

The best performing projects in crypto often have the strongest communities, prime examples being Chainlink and Synthetix. The community members are often what drives discussions, development and ultimately adoption and the network effects that stream from it. While it’s still too early to tell, by giving control of the entire protocol to YFI holders, it has lit a fire in the community.

Risks

Obviously with such great returns on yield farming, and Andre being famous for testing in “Prod” production/main-net, one would wonder about the risks involved.

Risks involved include:

1) The chance that anything (or everything) breaks. Andre has mostly used the Synthetix Contracts which have been audited as his base, but there hasn’t been audits on the $YFI staking contract yet.

2) Monetary policy risk, in the event where an unfavourable inflation schedule is passed by governance it may result in an exodus of liquidity from the platform, which would have rippling effects across the whole ecosystem without doubt.

3) Human risk. As there are no team tokens or any incentives paid out to Andre, he may decide eventually to stop developing the protocol, and that would lead to the entire Defi ecosystem losing out on the Satoshi of DeFi.

Conclusion

With the distributions of $YFI drawing to an end, the economic alignments and how the governance discussions have shaped up with high quality feedback from all over the community, Yearn.finance has proven by far to be the most interesting launch to date. The initial success of $YFI has given Andre Cronje a platform to implement his vision of DeFi. The yearn platform, by aggregating functionality across multiple protocols and leveraging the key idea of composability, is an ecosystem of products that redefines the idea of ‘money.’ It is now possible to earn interest, farm $BAL, $CRV (not yet released) and $YFI tokens, while also participating in governance, all by holding YCRV (yearn pool tokens). This is just the beginning as Andre continues to build out his existing platform to encompass a broader range of DeFi, including trading, leverage, etc.

Disclosure: The author is long $YFI and also one of the 9 multisig holders

ARTICLE BY:

Daryl Lau
@Daryllautk

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