What is a DeFi Yield Aggregator and How Do They Work?

Compound interest is the most powerful force in the universe.

But in DeFi, that means a lot of transactions to harness the compounding. 

Learn how DeFi yield aggregators solve this problem.

Key Takeaways

• As the number of different DeFi solutions grows, it becomes difficult to navigate their landscape and find the most profitable option for staking funds at every given moment.
• In order to withdraw the yield generated across different pools and protocols, users have to perform a lot of manual work. Also, they have to pay high transaction fees that reduce their APYs.
• Yield aggregators enable automated yield farming by forwarding liquidity from a single vault toward many different protocols. In addition, they help to find the best route in order to reduce transaction fees.
• Crypto aggregators are risky because they may fall victim to a bug exploit within any of the protocols they cover. 
• Other downsides of DeFi aggregators include liquidation and impermanent loss risks due to the high volatility of the crypto market in general.

What is a Yield Aggregator?

In DeFi, yield aggregators, also known as auto-compounders, act as optimization platforms for maximizing profit via automated yield farming.

With the ever-growing popularity of decentralized means of making passive income, they represent a new stage in the development of this market.

With the introduction of liquidity pools, yield farming has made it possible to gain stable returns on crypto investments in a fully automated and transparent way. 

In addition, the APYs that such solutions offer are much higher than those offered by banks and other centralized financial institutions.

At this, it comes as no surprise that the popularity of yield farming spiked in a blink of an eye. Yet, as the landscape of such solutions matures, investors come across another set of problems.

First, with the ever-growing number of DeFi protocols and liquidity pools, it’s become a challenging task to navigate them efficiently.

Next, different protocols come with different liquidity, fees, and other conditions. The larger their number, the more difficult it becomes to monitor them all. 

What’s worse, the yields they offer usually are not set in stone as they change together with the market. At this, finding the most profitable pool for placing funds in every given moment becomes practically unrealistic.

Finally, to withdraw their rewards, investors have to manually perform the claims and pay gas fees on every step. Oftentimes these fees are so high that they depreciate a significant part of these earnings.

This is where yield aggregators step into the light.

They solve these problems by combining liquidity from a large number of different sources into a single interface. Similar to fund managers in TradFi that help investors manage their portfolios, yield aggregators make it possible to gain higher returns in a more efficient manner.

How Do Yield Aggregators Work?

DeFi Yield aggregators introduce vaults where users may stake LP tokens. 

These vaults automatically identify the most profitable pools and protocols for staking at a given moment in time and deposit the liquidity accordingly.

Thus, their users can perform all their staking activities within a unified interface.

What’s more, DeFi aggregators help to reduce transaction costs. With the help of smart contracts, they optimize the transaction routing process so as to find the path with the lowest fees.

Thus, yield aggregators can help traders boost their profits and reduce manual work.

Risks of Yield Aggregators

Crypto yield aggregators represent a relatively new approach to yield farming. While the yields that they offer may seem really attractive, there are also a number of risks that investors should be aware of.

1. Bugs in smart contracts

DeFi aggregators combine not only various protocols but also all the possible bugs that these protocols may contain. Any bug when discovered may enable hackers to steal users’ funds while blockchain doesn’t offer any refund options to unlucky users.

2. Impermanent loss

Crypto yield aggregators often operate with automated market maker pools that combine a number of different digital assets. 

Any of these assets may increase or decrease in value disproportionate to other elements of this pool. Thus, the pool’s composition may change. 

At this, liquidity providers will bear impermanent losses which may lead to reduced APY for the users of liquidity aggregators.

3. Liquidation risks

In the worst-case scenario, the assets involved in liquidity pools may be liquidated. This may happen when the price of the collateral drops below the price of the loans.

Such an event will also reduce the rewards obtained from liquidity aggregators.

4. Scam risk

Unreliable DeFi aggregators with a lack of funding and proper reputation may easily shut down or perform an exit scam. 

Crypto winters that happen every 2 or 3 years have already sent to dumpster many projects. Some of the most prominent examples include Babylon Finance and DFI.money.

Other risks relate to the general volatility of the crypto market and the lack of consistent regulation of such services across different countries.

But still, they are not worse than any other dangers that cryptocurrency users may face.

At this, proper research of any given yield aggregator together with generic security practices can help investors minimize these risks.

Top Yield Aggregator Platforms

As the number of different yield farming solutions keeps growing in time, so does the number of yield aggregators.

At this, an analytical service DeFiLlama already lists a few dozen of such platforms. 

Some of the most popular options include the following:

• Yearn.Finance
• Beefy
• Falmincome

The solutions differ by the number of supported chains and the average APY that one may earn with their help. 

In order to choose the best option, one should carefully consider all the possible risks and make a thorough research.