Why higher APYs Can Be Misleading

The eye-popping yields (like 49.5% for a stablecoin LP) are often technically real at a specific moment but are unsustainable and misleading for several reasons:

1. Promotional Incentives & Token Emissions: New protocols or pools often offer temporarily high APYs to attract initial liquidity. This is known as "liquidity mining." These high yields are not generated from fundamental economic activity but are subsidized by the protocol distributing its own native tokens. Once the promotional period ends or the token rewards are reduced, the APY inevitably drops to a more sustainable level.
2. Volatility of Trading Fees: For Liquidity Provider (LP) positions, the APY is heavily dependent on trading volume. A sudden spike in market volatility can lead to a surge in trading, which in turn generates more fees for LPs and temporarily inflates the APY. The above example of 49.5% for a USDC-USDT LP could be likely based on a short period of unusually high trading activity, not a long-term average.
3. The Hidden Risks of Complexity: Higher APYs often correlate with more complex or leveraged strategies. While these can generate higher returns, they also come with increased risks such as:

• Smart Contract Risk: The more complex the protocol, the larger the attack surface for potential exploits.
• Impermanent Loss: For LPs in volatile pairs, the risk of impermanent loss can outweigh the yield earned.
• Liquidation Risk: Leveraged positions can be liquidated if the market moves against them.

The initial high figures often don't adequately price in these risks.

What Determines a Realistic APY?

The revised, more conservative figures are a better reflection of the true, sustainable yield you can expect to earn. These figures are determined by more fundamental and stable factors:

1. Sustainable "Real Yield": The most reliable yields are derived from fundamental economic activity on the blockchain. This includes:
2. Lending Interest: Interest paid by borrowers on platforms like Aave.

• Trading Fees: Fees generated from swaps on decentralized exchanges like Uniswap and Curve.
• Staking Rewards: Rewards for securing a network (e.g., ETH liquid staking). The revised figures (5-15%) are more indicative of this "real yield."

2. Risk-Adjusted Returns: The DeFi market is generally efficient at pricing risk. A simple, low-risk activity like lending a stablecoin on Aave (8.5%) will almost always offer a lower yield than a more complex, higher-risk strategy like providing liquidity to a newer protocol or using leverage. The revised numbers better reflect this natural risk-reward spectrum.
3. Current Market Conditions: In a "risk-off" or "extreme fear" market, as we are currently experiencing, overall yields compress. There is less demand for borrowing (reducing lending rates) and less speculative trading (reducing LP fees). The revised, lower APYs are consistent with the current cautious market sentiment.

Conclusion

It is essential to look beyond the headline APY and understand where the yield is coming from. By cross-referencing multiple reliable data aggregators (like DeFiLlama, De.fi, etc.) and understanding the underlying sources of yield and risk, you can make more informed and sustainable investment decisions.

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Disclaimer: The content of this blog is for informational purposes only. It is not investment advice. Please do your own research and consult with a qualified financial advisor before making any investment decisions. DeFi investments carry significant risks, and past performance does not guarantee future results. More details here.