Yield farming potential: Curve stability and composability

The Curve protocol began its journey towards decentralized governance by starting a Decentralized Autonomous Organization (DAO) to oversee protocol changes. Most DAOs are governed by governance tokens that grant voting rights to token holders. In this case, the Curve DAO is controlled by the CRV token, but first what is Curve, and is it a reliable platform for yield farming?

What is curve?

Curve operates as an AMM platform that shares similarities with Uniswap and Balancer, but differentiates itself by exclusively accommodating liquidity pools consisting of assets that behave similarly to stablecoins, or wrapped versions of such assets such as wBTC and tBTC. This approach enables Curve to use more efficient algorithms, exhibiting the lowest levels of fees, slippage and permanent loss among decentralized exchanges (DEXs) on Ethereum.

Let’s start with a quick refresher on how AMMs operate and then we can delve into how Curve achieves reduced risk and increased efficiency compared to other AMMs in the DeFi ecosystem.

How do automated market makers work in curve?

Automated market makers facilitate the permissionless and automated trading of digital assets using liquidity pools instead of direct trading between buyers and sellers. Essentially, a liquidity pool represents a common pool of tokens. Users contribute tokens to liquidity pools, and the token prices within the pool are determined by a mathematical algorithm. By adjusting the algorithm, liquidity pools can be optimized for various purposes. Any individual with internet access and some ERC-20 tokens can become a liquidity provider by contributing tokens to an AMM’s liquidity pool. Liquidity providers typically earn a fee (paid by traders who interact with the liquidity pool) for providing tokens to the pool.

Stable liquidity pools

Curve was launched in 2020 with the goal of establishing an AMM exchange with nominal fees for traders while providing an efficient fiat savings account for liquidity providers. By focusing on stablecoins, the platform allows investors to sidestep more volatile crypto-assets while still earning substantial interest rates from lending protocols. Compared to other AMM platforms, the Curve model takes a particularly conservative approach, eschewing volatility and speculation in favor of stability.

On AMMs like Curve, liquidity pools consistently seek to “buy low” and “sell high.” Here’s a refresher on how this rebalancing works, this time with USD-pegged stablecoins USD Coin (USDC) and DAI.

If you sold DAI on Curve, you would initiate this series of actions:

Additional DAI is injected into the pool. It becomes unbalanced as there is now an excess of DAI compared to USDC. The pool downloads DAI at a slight discount relative to USDC to incentivize balance. It adjusts its DAI to USDC ratio.

By selling DAI at a discount, the pool attempts to restore its original state. As assets in the it’s pool are stable in price relative to each other, trading between them has minimal volatility compared to other AMM liquidity pools. In AMMs like Uniswap or Balancer, where liquidity pools can consist of any token, volatility is significant. By limiting the pools and the types of assets in each pool, Curve mitigates permanent loss, an AMM phenomenon where liquidity providers suffer a loss in token value relative to the market value of that token due to volatility in a liquidity pool.

Note: permanent loss is not always detrimental. Volatility and slippage present opportunities for users seeking to profit from entering and exiting a liquidity pool at the right time. By forgoing the high-risk – and sometimes high-reward – aspect of volatility, Curve instead lures liquidity providers through what is known as DeFi composability. This means you can use your investments on the Curve platform to earn rewards elsewhere in the DeFi ecosystem.

Yield Farming CRV Tokens

The CRV token can be purchased or earned through yield farming – when you deposit assets into a liquidity pool and receive tokens as a reward. By providing DAI to a designated Curve liquidity pool, you earn the CRV token in addition to fees and interest. Yield farming the CRV token reinforces the incentives to become a Curve liquidity provider, as you gain not only a financial asset, but also ownership of a robust DeFi protocol.

Composability and yield farming

On an AMM exchange like Uniswap, you can earn fees when a trade takes place. On Curve, trading fees are lower than those on Uniswap, but you can also earn rewards from external tokens thanks to interoperability.

For example: When DAI is lent on the Composite platform, it is exchanged for a liquidity token called cDAI, which automatically accrues interest for the holder. Holding cDAI gives you the right to withdraw DAI along with interest from Compound. Curve users can use cDAI in its liquidity pools, thereby gaining a secondary layer of utility and potential earnings from the same investment.

The ability to use Compound’s cTokens on Curve illustrates the benefits of composability in the DeFi ecosystem. Compound is simply one example of an external DeFi protocol that the platform integrates with. The protocol also integrates with Yearn Finance and Synthetix to maximize incentives for liquidity providers.

In closing

Curve is one of the most popular platforms in DeFi due to its preference for stability and composability over volatility and speculation. Its constituent aspects make it an interconnected core of the DeFi ecosystem, and with the CRV token serving as a governance mechanism, it represents an exceptionally decentralized organization owned by its users, where they can earn passive income through various means, including yield farming.