In my 2024 year-ender essay, I wrote about my realization that I didn't particularly enjoy day-trading crypto. So over these recent holidays, I've gone back to farming ... YIELD farming, that is. For the unfamiliar, this is the act of placing your funds in financial instruments that produce profits slowly over a given time period. Some of you are already doing a simple form of yield farming when you deposit your money in any of the Philippines' new digital banks, earning 4-5% per annum. Of course, in the crypto world, finding and farming the best yield isn't simply a matter of comparing interest rates (more commonly referred to as the APR or "Annual Percentage Rate") — there’s a lot more to it than that.

Which brings me to my newfound obsession: Aerodrome. As you may or may not know, Aerodrome is the primary exchange of the Ethereum Layer 2, Base. Base was itself one of the rising stars of 2024, and Aerodrome is one of its cornerstone projects. Before we go any further, let’s do a quick refresher on how decentralized exchanges like Aerodrome work. Unlike their centralized counterparts, DEXs begin their lives as little more than a gaggle of smart contracts, and have to bootstrap their exchange operations from nothing. In order for a DEX to be able to execute even the most basic conversion of ETH in exchange for USDC, for instance, some generous users have to first lend their tokens to it. We call these user contributions "liquidity pools," and they're organized in terms of the trading pairs they handle: ETH/USDC is a pool with both Ether and USDC in it, BTC/USDT is another. You need a pool for every crypto you want to be able to support, so most DEXs will have hundreds of them in varying sizes.

So when you sell your ETH on a DEX, you're actually being paid with someone else's USDC from that liquidity pool, and you’re being charged a small trading fee. It's this trading fee that makes being an LP worthwhile. If my contribution to the pool is 1% of the total size of the pool, then I earn 1% of all its trading fees. On any given day, Aerodrome's ETH/USDC pool by itself sees over $500M in trades, and its LPs receive about $200K in fees (~0.4%). Across the entire Aerodrome DEX, daily trading often reaches a billion dollars, paying out over a million dollars in total fees to its LPs.

Those earnings are further boosted by incentives paid in $AERO, Aerodrome's own token. When combined with the earnings from trading fees, it is not uncommon for Aerodrome's liquidity pools to advertise APR in excess of 100%. Yes, you're reading that right. It's basically estimating that you could double your money in a year's time. Now, the operative term here is "estimating," because the APR is dynamically calculated minute-by-minute depending on how much trading activity is actually going on. Over the weeks that I've had money in these pools, I've seen the APR estimates go as low as 60% and as high as 800%. You can claim your Aerodrome rewards in real-time, and you can also cancel and withdraw all your funds whenever you like. Because I prefer my gratification to be instant, I've been withdrawing my profits everyday at 5pm and squirreling them away as USDC.

Over the last 2 weeks, I've earned more from this farm than from my full-time job during the same time period. Yes, I realize that that is a very limited timeframe, but I’ve also run a dozen different trials since December, and I wouldn’t be writing about this if I wasn’t confident that the yield was real. You've probably guessed that the size of my rewards means that I made a pretty big deposit … but it wasn't as big as you might think. Without sharing the actual numbers, I deposited LESS than a year's salary, but I'm currently earning MORE than a year's salary if we extrapolate the daily rewards I’ve been harvesting. (In other words, the effective APR was greater than 100%.) I know that that sounds too good to be true, so I need to emphasize this: the daily rewards are dynamic and will change over time.

So now let's talk about downsides. The most obvious one is that both Aerodrome and Base are young, and we can't draw any long-term conclusions about how sustainable this all is. Beyond just the blockchain risk and the protocol risk, there's also varying levels of price volatility risk since you're holding two separate cryptos … although in my case, I’m working with just ETH and USDC, so I’m less worried about the price movement. I experimented with six other Aero pools, but found that ETH/USDC is the best balance of risk/reward for me. If you were LP-ing a bunch of memecoins, the rewards would be much higher, but your risk would also be exponentially greater. (And I imagine your stress levels would be much higher as well.)

But of course the biggest downside is the DEX-specific phenomenon of "impermanent loss," which is the term we use to describe how the pool rebalances itself and affects your original deposit. In DEX LPs, your deposited cryptos will continually adjust their respective amounts while mostly maintaining the cumulative dollar value of your original deposit. Every LP deposit must include equal amounts of the two cryptos in the pool, so let’s say you deposited 1 ETH and 3500 USDC. That means that the total value of your deposit was originally $7000. Let’s pretend the ETH price went up to $3600, what happens then? Well, the pool will rebalance by giving you less ETH and more USDC, such that the total value of your deposit remains the same at $7000.

If you withdraw your funds from a pool, you won’t get the same amounts of crypto back, but you will usually get the same dollar value back from when you first opened the position. I say “usually” because if the price of ETH dropped drastically (greater than 4-5%) and you weren’t paying attention, then you would lose at least 2%. If you already have some familiarity with IL, you know that I’m oversimplifying here for brevity’s sake. But if you’re not familiar with IL at all, you need to spend a lot of time reading up on it before making any moves. Overall, I think IL is manageable if you’re keeping a close eye on the market, but you can’t afford to just let your assets sit there without monitoring them.

Before I sat down to write this newsletter, I debated whether I should even be featuring this yield farming strategy. It’s far from a “passive investment” because of how closely you need to monitor it. I think I’m spending at least 30 minutes each day on this farm, which makes it a fairly “active investment.” Now to be fair, that is more due to my deposit size — it isn’t small, so my paranoia is high. But in the same way that real-world farming involves a regular interaction between the farmer and his crops, this kind of yield farming also requires frequent monitoring and a steady hand. I’ll admit that it feels like walking a tight rope, and my confidence level is not yet high. However, I am emboldened by the fact that I can cancel anytime and get my funds out of there at a moment’s notice. Importantly, I wanted to lean into the Base ecosystem hard this year, and this seems to be the most direct way for me to participate for now.

Also, the yield is pretty nice.

Be careful out there, cryptofam!