'Why were Yields So High in Crypto?' - Arthur Breitman on Crypto Yields in 2021

Tezos co-founder Arthur Breitman unpacks some of the reasons why yields were so high in 2021.


1,000 words, 5 minute read

In the world of traditional finance, ‘yield’ refers to the cash-flow or income that an investment generates. This is distinct from a capital gain, which marks the increase in value of an asset that is realized once it is sold. In 2021, the crypto world saw extremely high rates of yield, and in his recent YouTube video, ‘Why were Yields So High in Crypto?,’ Arthur Breitman explains all. In the video, which you can watch in full at the top of this page, he discusses some of the reasons behind this phenomenon, including some of the misconceptions that people commonly attribute to it.

Ultimately, according to Breitman, the answer to the question of why yields were so high last year may not necessarily be what you think.

Why were yields so high? - The WRONGEST Explanation, and one that begs a question:

It’s people saying, “Well, yeah, of course yields are high because that’s crypto and it’s great and that’s a new paradigm, higher yields.” This is dumb, right? There’s such a thing as arbitrage. If you have higher yields in one place and lower yields in another place, these things tend to equalize. So you have to wonder why are they not equal? Why did you see in a real economy lower yields than you saw in crypto? That’s what you need to explain.

Yield definition #1: Staking Rewards

Different things are being referred to as yield by different people, and I think that’s misleading. There’s three broad categories that I would see. One is staking protocols, and by that, I mean […] Proof-of-Stake validation […]. It’s not yield in the sense of a bond; it’s in the sense of you get rewards in the same way that the miners get paid for getting blocks. […] In Tezos, if you are efficient at picking [your baker], you’ll beat inflation by just about 1%, which is nice, but it means it’s not 6%. It’s 6% minus 5% give or take.

Definition #2: Taxes & Farming

The second category is taxes. So Sushi Swap figured out in 2020 that they could bootstrap liquidity by giving away a token to people who are adding liquidity and saying, “Ah, maybe this token is valuable in the future, so if you want this valuable token, add liquidity now.” This brings liquidity, which brings trading volume, and then the trading volume can make it self-sustaining because the fees from the trading volume keeps the liquidity present. That’s a theory.

It can work, but then it became a ‘degen’ thing where you had this 1,000% yield and it’s basically a useless token that’s being pumped up, and people just buy the token and very quickly it loses its value. So it advertises very high yield, but in practice, you have tons of impermanent loss. You have a ton of inflation that’s associated with that. So here you can understand why those so-called yields are high. It’s not really yield.

Definition #3: Lending Protocols & Risk

And the third [category], which is much closer to what is referred to as ‘yield’ in finance, is lending protocols […] the general principle here looks a lot more like traditional yield. Someone has risky assets, they borrow against those risky assets, and then they borrow at a certain rates.

Now why is that rate high? The answer most people will give you is, “Oh, because it’s so risky.” If you have a high rate in one place in the economy and another rate which is lower, clearly the difference has to be explained by risk. It’s a simple explanation and it’s partially true, but it’s not entirely true. […] Yes, clearly there was risk, but a lot of [correctly written lending protocols] didn’t go belly up.

Capital Shortage

The other [potential] explanation, which is not risk and which I find quite interesting, is capital shortage. In this scenario, you had a bunch of demand for borrowing and it was a shortage of capital. Not enough money was able to flow from regions of the economy where you have low rates to this region where you have high rates.

And I think the main barrier here would’ve probably been regulatory […] You have people who want to use DeFi, they want to stay on-chain, they don’t want to use centralized actors. But on the other hand, you have traditional lenders who also don’t want to touch this DeFi. Or even centralized crypto lending, it’s crypto, but they don’t want to touch it.

Was it all Anchor/Luna?

Another explanation, which I saw recently, which I think is interesting, is that actually it was all Anchor. It was all Luna. The yields were so high in Luna because they were artificially propped up by inflation of the collateral. […] That’s possible, but the appetite for leverage started before Luna became a big thing. […] I think we just generally had bull markets, and people wanted more exposure, more leverage during the bull markets. They borrowed and institutional lenders were not available to actually offer something.

Looking forward:

Why is that important? It’s important because […] the market conditions may change at some point. And if and when they do, and demand eventually returns, we will see higher rates return. And when that happens, I think a lot of people will say, “Ah, people haven’t learned their lesson. It’s all risk again.” And at that point, I think it’s interesting to look at the difference and say, “No, it’s not all risk.” And what is interesting is how do we actually get those rates down? How do we get more lending available on blockchains, on public decentralized blockchains in a way that works with traditional lenders?

[T]here was definitely a lot of risk in the system [in 2021]. But if you think risk is the whole story, I think that’s too simple of a story.