How Do Yield Aggregators Work?

Profit in the field of decentralized finance is formed from practically the same sources as in the traditional financial sector. The primary source of profit (or loss!) is trading in volatile assets. Assets, in this case, include cryptocurrencies, including coins, tokens, synthetic assets and other financial instruments.

The second source of profit is the services that provide the opportunity for this trade. Services form an infrastructure consisting of exchanges, loan services, price oracles, etc. The profit of this infrastructure is mainly generated by commission fees.

The main profit generators in DeFi are decentralized exchanges and loan services. Yield Aggregator optimizes the ways to get this profit for maximum efficiency.

When a liquidity provider provides its tokens to the DEX liquidity pool, it carries the risk of “impermanent loss”. Despite the fact that the liquidity provider receives some share of the DEX commission fees, sometimes this is not enough incentive for him. A greater incentive is provided to him by the farm in which he deposits his LP-tokens. The farm pays him rewards in its own tokens of the service in which this farm is located. There are a wide variety of farms not only for LP-tokens but also for single token stakes. However, the principle of operation is the same for them.

Let's say the user wants the farm to withdraw his rewards by itself, convert them into tokens, and deposit them back into the farm (single or LP-tokens), and thereby constantly increase his deposit and, consequently, profit.

There are vaults for this purpose. They differ from farms in that they can perform auto-compound of the deposit at certain intervals of time. For example, every minute or every 5 minutes. Vaults can automatically compound not only LP-tokens but also single tokens, which in turn can be deposited in a loan pool, for example, in AAVE.

Yield Aggregator can include hundreds of farms and vaults that generate profits from dozens of different decentralized services with different business models. The user does not even need to do anything, the Yield Aggregator does everything for him. For this work, the vaults charge a certain percentage for each automatic compounding.

In general, so that the user does not do this:

The Yield Aggregator does this for the user:

How does all this work in an integrated way? To find out, it is necessary to investigate the system, so to speak, from the inside. As an example, let's look together at the system of one of the large Yield Aggregator combined with DEX.

Do not be afraid of a pile of blocks and arrows! In fact, there is nothing super-complicated here. Let's start with the left part of the diagram.

Old Vaults (with auto-compound) buy FISH tokens (governance token and profit distribution token) on DEX and send them to a dead address (burn). For this purpose, the Old Vaults use 4.5% of the profit. Vault users pay this fee for automatic compounding.

The New Vaults use the same 4.5% of the profit in order to increase the Dividend Funds in a certain proportion (according to the decision of the vote of the FISH holders). The Dividend Funds are also vaults, but they do not have the auto-compound function, since all the profits they generate are sent to DEX to buy PAW tokens (a DEX token to reward liquidity providers). 100% of the purchased PAW tokens are sent to the Dividend Vault for the payment of rewards to FISH holders.

There are actually more than four vaults in dividend funds. They are simply grouped by the level of risk and profitability. These vaults can contain not only LP-tokens but also, for example, can be loan-pools with a single token. Thus, these funds contain significantly diversified assets, as a result of which they are resistant to various risks. Thus, the FISH token actually represents a share of these funds and its holder receives a certain share of the profit.

It can be concluded that the service is almost completely decentralized since the level of user participation in the control and distribution of profits is determined only by the number of FISH tokens that he owns. This is a significant difference from many other Dapps, where the governance token does not give any rights to participate in the distribution of profits.

Now let's see how the DEX commissions for trading transactions are distributed.

At first look, it may seem that this is not very inefficient, since there is no linear dependence of the volume of PAW burning on the volume of transactions on DEX. However, the advantages of this method are that with the constant growth of the vault, the volume of PAW burned also increases. This burning system slowly "accelerates”, but then acquires a large "inertia of movement". The most important result is that even if the trading volumes on DEX stop completely for some time, this will not affect the volume of PAW burning.

The best confirmation of the effectiveness of the Burning vault system is that many development teams have already copied this method for their Dapps from the developers of this service.

Well, only the block of farms remained on the diagram. There is nothing special here, this is a common system of token farming, as in other services.

As you can see, the seeming complexity of Dapps in DeFi is not really a puzzle. The Yield Aggregator that we have reviewed is Polycat on the Polygon blockchain. After we have unraveled the intricacy of the arrows on the diagram together, we can already see what Polycat actually looks like:

Dapps developers strive to create user-friendly services and, in general, there are not so many super-complicated systems in the field of decentralized finance. This is also evidenced by the continuous growth in the number of DeFi users. If you haven't discovered this “terra incognita” yet, take your first step into the future of the financial system.