FOLLOW THE MECHANISM
- 1Underlying activity
Capital supplies credit, inventory or another service.
- 2Receipt and rewards
- 3Exit
Unwind every layer and value the assets actually recovered.
A conceptual sequence. Real implementations can add steps, intermediaries, and conditions.
A strategy rather than one mechanism
Yield farming means arranging assets across protocols to earn rewards, often including incentive tokens. The underlying activity might supply loans, provide pool liquidity or stake a position token in a distributor. These activities have different obligations and losses. Depositing an LP token into a rewards contract does not turn the underlying pool into proof-of-stake consensus. A productive first question is what the asset is doing when rewards are absent, because that reveals the mechanism beneath the promotion.
Separate revenue from subsidy
Borrowers pay lending interest, traders pay pool fees, and proof-of-stake protocols pay consensus rewards under their issuance and fee rules. Incentive programs may instead distribute tokens from a treasury or new issuance to attract activity. These are transfers with a funding source, not free value created by an interface. A token-denominated payout becomes a dollar yield only after choosing a token price and accounting for the ability to sell. New tokens may dilute existing holders, and their market price may fall.
Layering creates a dependency chain
A strategy can deposit assets into a pool, place the pool receipt in a rewards contract, and put that receipt into a vault. Each layer may add fees, permissions, withdrawal conditions and software. The final balance is a claim through those layers rather than direct possession of all underlying assets. Combining lending and liquidity provision can also add liquidation or inventory risk. A diagram should show each receipt separately, so the same underlying capital is not counted repeatedly as new economic value.
Nominal yield is only one line
An annualized reward display can extrapolate a short period at changing prices and participation levels. Net return also includes asset-price changes, divergence loss, borrowing costs, performance fees, transaction costs and unrecovered losses. Rewards may end or be unclaimable when an exit is needed. Audits can examine selected code and assumptions but do not guarantee a strategy’s economics. Compare transparent cash-flow components rather than treating a high advertised percentage as a complete description of the position.
MAKE IT CONCRETE
Illustrative net accounting
A position starts at 1,000 units of reference value, earns 60 in fees and 40 in incentives, but loses 120 through inventory changes and pays 15 in costs. Its net result is −35, not the advertised 100 reward total.
FAILURE PATHS & COMMON MISREADINGS
Where the model can break
KEEP EXPLORING