Where does crypto yield come from?

Yield is a payment from someone

A yield figure is a yearly percentage: how much you earn compared with what you put in.⁶ The number on its own says nothing about who is paying it. This module asks that question every time.

Four sources of yield come up again and again.^1,2,3,4

Staking rewards

Staking means locking up a network's coins to help run it, as Module 2 explained.⁷ Staff at the US Securities and Exchange Commission (SEC) describe two kinds of reward for validators on these networks.¹

• New coins, created by the network and paid out under its own rules.¹
• A share of the fees that users pay to get their transactions added.¹

On Ethereum, a validator that proposes a block also earns fees and MEV.⁷ MEV, or maximal extractable value, is the extra value a block producer can take by choosing which transactions go into a block and in what order.⁸

New coins come at a price. Creating them adds to the supply, and ethereum.org says the balance between new ETH and burned ETH sets ETH's inflation or deflation rate.⁹ Lesson 5 comes back to this.

Lending interest

On a lending app, the yield is the interest borrowers pay. Aave's FAQ says suppliers share the interest paid by borrowers, and that the more of a pool is borrowed, the higher the yield for suppliers.² A slice of borrowers' interest, called the reserve factor, goes to the protocol's treasury instead.²

So lending yield depends on demand to borrow. A 2021 BIS article said DeFi had few real-economy uses and mostly supported speculation and arbitrage.¹⁰ Module 20 covers lending in detail.

Trading fees

On a decentralised exchange, liquidity providers earn a cut of what traders pay. Uniswap's documentation says each v2 trade pays a 0.3% fee, shared pro rata among the pool's liquidity providers.³ Module 17 covered these fees, and the risks that come with providing liquidity.

Token incentives

Some yields are paid in a project's own tokens, to attract users. In September 2020, Uniswap launched a "liquidity mining" programme. It shared 5,000,000 UNI per pool, in each of four pools, among the pools' liquidity providers, in proportion to how much each had put in.⁴

The Financial Stability Board (FSB) describes "yield farming": lending or borrowing crypto across DeFi platforms to earn crypto rewards.¹¹ A reward paid in a new token is only part of the picture. Lesson 5 shows how to check whether new tokens are being created faster than you earn them.¹²

When nobody is paying

Sometimes there is no real activity behind the number at all. The SEC's investor website says a Ponzi scheme is a fraud that pays existing investors with money collected from new investors.⁵ With little or no real earnings, it needs a constant flow of new money to survive.⁵

ethereum.org gives a simple test for staking products. If a yield is meaningfully higher than the network's own staking rate, ask exactly where the extra comes from.¹³