The decentralized finance (DeFi) space has seen explosive growth over the past couple of years, with total value locked in DeFi protocols surpassing $100 billion in early 2022. One of the main drivers of this growth has been the attractive yields offered on crypto assets through yield farming and lending/borrowing protocols.
However, as competition intensified, yields started falling across DeFi platforms. This led to the emergence of «yield stacking» or «yield aggregation» strategies, where users spread their funds across multiple protocols to maximize returns. The latest evolution of this concept is stackable yields through structured products like Index Coop’s ETH2x-FLI.
What are Stackable Yields?
Stackable yields refer to generating multiple layers of yield by stacking different yield-bearing assets or strategies. The aim is to compound returns and optimize yield farming outcomes.
For example, a user can deposit ETH into a lending protocol like Aave to earn interest. The aTokens received in return can then be staked or used as collateral elsewhere to earn additional yield. When done across multiple DeFi protocols, this can result in highly attractive annual percentage yields (APYs) through the compounding effect.
Key Innovations Making Stackable Yields Possible
A few key innovations in DeFi have enabled the rise of stackable yields:
- Interoperability via wrapped tokens and bridges: Wrapped versions of assets like wBTC along with bridges allow porting tokens across chains, thereby increasing the yield opportunities.
- Auto-compounding vaults: Platforms like Yearn Finance have popularized auto-compounding vaults that reinvest earned yields to keep compounding returns.
- Emergence of index tokens: Tokens like FTX’s DeFi index provide bundled exposure to multiple DeFi assets, allowing users to earn a share of yields from the underlying protocols.
- Structured products: Financial engineering is being used to create structured products optimized for stackable yields.
ETH2x-FLI — A Structured Product for Maximizing Stackable Yields
A newly launched structured product called ETH2x-FLI from Index Coop illustrates the growing sophistication of stackable yield techniques. It is an index token collateralized by ETH with a target leverage ratio of 2x. The ETH collateral is deposited into Aave to earn yield, while the FLI tokens can be staked in Convex to earn additional yield plus rewards.
This creates multiple layers of stackable yields:
- Yield on ETH deposits in Aave.
- Leveraged exposure to ETH via 2x leverage.
- FLI staking yields from Convex.
- Potential protocol reward tokens from Convex.
As a result, ETH2x-FLI is designed to optimize yields for ETH bulls who want amplified exposure to gains. The backtested annual percentage yields are enormously attractive, often exceeding 100-200% APY during bull markets.
For users who already have ETH, ETH2x-FLI provides a way to maximize their earnings without having to directly engage in complex yield farming strategies. This makes leveraged yield stacking much more accessible.
Risks and Drawbacks
Stacked yields certainly offer tantalizing returns, but do come with a set of risks:
- Impermanent loss due to volatility.
- Liquidation due to over-leveraging.
- Smart contract risks.
- Platform governance risks.
- Regulatory uncertainty.
The 2x leverage in ETH2x-FLI also means amplified losses in bear markets. Therefore, managing risk is crucial when venturing into yield stacking strategies. There are also capital inefficiency issues when trying to move funds across too many protocols.
It’s important to have a prudent strategy about how much to allocate to these leading-edge DeFi structured products and actively manage risks.
Stackable yields represent an evolution of capital efficiency in crypto, compounding returns across multiple protocols and products. Platforms like Index Coop are pioneering new yield-optimized structured products. For savvy DeFi users, stackable yields provide a way to maximize APY. However, the risks must be weighed carefully.
Overall, structured products open up leverage yield stacking to a wider audience of participants. As the market infrastructure improves further, stackable yields are poised to drive a new wave of innovation and adoption in DeFi.