In our introduction to yield farming article [link] we explained how yield farming can generate profits. In this article we will focus on the automation of yield farming by using vaults.
Introducing: Vaults #
Vaults are well suited for investors who don’t have the time to research the next-best yield farming opportunities. Vaults are pools of funds with one or more investment strategies. Because vaults use various complex investment strategies to maximize profit, investors no longer need to spend time and fees researching yield farming opportunities.
Vault strategies are typically designed by the vault platform community. The developers of the strategy receive a small percentage of the fee that investors pay when they withdraw their assets from the vault.
The strategies can be extremely diverse. This allows vaults to interact with different DeFi protocols to maximize profit. When a certain DeFi platform stops offering a high yield, a vault can switch strategies and switch to another platform for higher yields.
To ensure that liquidity is always available in the vault, not all assets are used for investing. There is always a certain amount of assets in the vault that remain idle. This allows investors to retrieve their assets from the vault. By doing, vaults do not have to remove the assets from the various DeFi protocols. This has the advantage that gas fees are kept to a minimum.
When an investor removes his assets from the vault, he will have to pay a withdrawal fee for any gas costs incurred as well as the vault strategy fee for the developers of the vault.
A great advantage of vaults is that, no matter how complex their strategies, the investor always gets his initial assets minus the withdrawal fees back from the vault when withdrawing.
As an example, suppose an investor deposited $100 worth of BNB into a vault. As part of the strategy, the vault swaps the BNB to CAKE tokens. If the investor decides to withdraw his assets from the vault, he receives back his BNB tokens, instead of CAKE tokens. This is possible is because the vault has – as mentioned above – a fair amount of assets that remain idle.
Example of a Vault #
An easy to grasp example of a simple vault strategy is the bDIGG/BTCB Vault from badger.finance. Badger focuses on generating high yields for Bitcoin pegged tokens such as WBTC and BTCB.
The vault strategy is as follows:
How the vault works:
- The first step for the investor is to provide liquidity in the bDIGG/BTCB liquidity pool of Pancakeswap.
- Then, the investor has to deposit his received PLP tokens in Badger’s bDIGG/BTCB vault.
- The vault stakes the PLP tokens into Pancakeswap’s farm pool to generate CAKE tokens.
- All generated CAKE is staked in CAKE syrup pools to earn more CAKE.
- The generated cake is swapped to DIGG and BTCB.
- The DIGG and BTCB is deposited in the DIGG/BTCB liquidity pool.
As you can see, the vault optimizes and automatically executes every step in the strategy. This saves the investor precious time and daily fees, compared to performing these steps manually.
Existing vault platforms #
Due to DeFi becoming increasingly popular, a lot of vault platforms and vaults have been launched within a relatively short time. Below is a list of the most popular vaults (+ their network compatibility) in the DeFi space:
- Badger.finance (Ethereum, BSC)
- Vesper.finance (Ethereum)
- Idle.finance (Ethereum)
- Autofarm.network (BSC, Polygon, HECO)
- Yearn.finance (Ethereum)
- Harvest.finance (Ethereum, BSC)
The risks #
Like any financial product that makes use of smart contracts, vaults don’t come without risks.
Because vaults usually use complex smart contracts in order to interact with multiple defi protocols, they are more prone to bugs and exploits. This can results in big losses for investors. Vaults that utilise stablecoins have the added risk that the stablecoin used in the strategy may lose its peg, which can lead to major losses.
Another risk of vaults is liquidation. This can happen when borrowing assets is part of the vault’s strategy. Typically, a collateral of 200% is needed in order to borrow 100% of another asset against it. If the collateral suddenly drops below 150%, due to a price drop of the asset, the vault can be liquidated. If this happens, the vault will need to refill the collateral back to 200% within a certain period of time. Vaults are programmed to intervene should this happen, but this does not guarantee safety of the assets.
Vaults are very convenient for investors who don’t have the time to constantly research yield farming opportunities within the DeFi space. Once assets are deployed in a vault, it can apply its strategy to maximize the returns. Due to the user-friendly nature of vaults, it is expected that they will continue to increase in popularity.