Yield farming is one of the more powerful trends in decentralized finance today. Anyone can put their [crypto] assets to work, although it involves a significant amount of trust. In a perfect world, which I think is within reach, anyone can earn yield on their assets natively.
Why Yield Farming Requires Trust
Anyone who has interacted with a decentralized finance protocol or website will notice a relatively big problem reasonably quickly. Nearly all of these solutions require users to deposit funds into a smart contract. Although that contract is a form of decentralization, users also have to rely on developers' coding skills. Unfortunately, the DeFi industry has been subject to many inadequate smart contracts and vulnerabilities, putting user funds at risk.
As millions of dollars have been hacked, stolen, or lost since the inception of DeFi, there has been a growing demand for smart contract audits. Reputable firms will analyze the code and point out weaknesses, flaws, and security holes for a fee. I am a big proponent of smart contract auditing, yet it appears there are still many projects that do not undergo such a peer review for a variety of reasons.
Until that situation changes, I fear there will be even more issues about DeFi smart contracts. Although some incidents have been resolved peacefully and with minimum loss to platform users, the situation needs to improve quickly. A $100 billion+ industry needs to embrace standards to make sure user funds are kept safe. Smart contracts are not infallible, as humans create them. We all know human coding is subject to bias, shortcuts, and perhaps even a lack of best security practices.
There may be alternative ways to address the popularity of yield farming in DeFi. An approach where one doesn't need to interact with smart contracts at all. I would love it if my assets could generate yield independently without any particular interaction on my behalf. Until recently, that seemed like an impossible dream, but it is a bit more realistic today.
Protocol-Level Non-Custodial Yield Farming
Allow me to explain the hope I have a bit further. Every asset on a blockchain borrows the elements of the core protocol found within that ecosystem. So, for example, Proof-of-stake blockchain assets will inherit the native staking opportunity from the network. It remains up to users to engage in that staking, but it does not require interacting with any contract or wallet that isn't under their control.
Ideally, we need a similar solution for the decentralized finance space. The ability for assets to natively generate yield without trusting any contract or third-party service is essential. Native blockchain protocols have tremendous potential, although no DeFi-related options have been explored today. That is not too surprising, as the technology is still relatively new. However, a protocol-level yield generation solution can prove incredibly powerful.
Unfortunately, to generate yield on assets natively in DeFi today, users are subject to over-collateralization. It is far from ideal, as users need to provide far too much liquidity for minimal gains. Moreover, yield rates can fluctuate wildly, as do the values of the assets one uses as liquidity. It is a perilous game that can be compounded further by transaction fees, congested networks, et cetera.
Instead, digital asset owners like myself should be able to generate asset yields without relinquishing custody. Interest-bearing tokens are the next breakthrough for decentralized finance. If these assets can become viable across multiple DeFi protocols and products, we are one step closer to ushering in the era of financial freedom.
How Can it Be Achieved?
All of the above sounds great in theory, but is it even viable in the real world? I recently came across an explanation by Horizon Finance that would make it possible. Through this DeFi protocol, users receive tokens representing a derivative Interest Rate payoff.
More specifically, that function represents the realized yield of the underlying asset over a specific period and the arrangement of other players' bids for that round. Thus, combined with the staking of the native token, there are many possible yield streams without interacting with smart contracts or third-party services.
Introducing floating and fixed interest rate markets into DeFi can change the entire industry narrative. Users can bid in and out of fixed and floating interest rates with relative ease, assuming there will be sufficient liquidity. Initially, this process will only work for short to mid-term tenors, but it is possible to expand it to much longer tenors if the concept proves successful.
The service could pave the way for more accessible DeFi non-custodial yield farming without having to worry about unnecessary complexities. I am intrigued by the team's plan to introduce an automated yield configuration, which acts as a robo-advisor of sorts. Users can build their portfolio yield based on preferences across different pools, tenors, and choices for fixed or floating interest rates.
Coming Soon
It is commendable to see developers and experts tackle core aspects of decentralized finance by introducing new solutions. I am a fan of the protocol-level non-custodial yield farming concept and expect it to make a significant impact over the coming months and years.
DeFi can be an unnecessarily complex industry, yet it still provides tremendous potential to all participants. If the vision above comes true and developers can automate it somehow, nothing is preventing the mainstream adoption of decentralized finance.