April 11, 2024 • 7 minute reading time

Yield Farming on Solana

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Solana HFT

In this article, we explore what yield farming is, different opportunities on Solana today, and the important risks and considerations involved. 

What is Yield Farming? 

Yield farming is an ROI-optimizing strategy which can be carried out across one or more blockchain-native applications. Originally coined in the heat of DeFi Summer and the 2020-2021 crypto bull run, “yield farming” has become an umbrella term for blockchain-native financial strategies that seek to capture profits from various protocol and network incentives. 

At its core, yield farming simply involves depositing an asset into a smart contract programmed to accrue monetary rewards through real yield, i.e. trading fees, and/or inflationary token emissions.  The origins of yield farming can be traced back to Synthetix and Compound Finance, which began distributing their native governance tokens to incentivize liquidity and users to their borrowing protocols. The frenzy picked up and more teams began to follow suit, implementing various incentive distribution mechanisms in order to grow their protocols. Today, yield farming is a cornerstone of DeFi, existing across many different blockchains and applications, including our home, Solana. 

Yield Farming on Solana - AMMs 

The most common form of yield farming is liquidity provision on automated market maker (AMM) protocols. Pioneered by Uniswap in 2018, AMMs utilize a simple two-party system of swappers and liquidity providers (LPs), which work together to facilitate decentralized trading. LPs earn yield from trading fees and inflationary token emissions - though it is worth noting that this is far from a risk-free endeavor.  

Liquidity pools are smart contracts programmed to maintain a 50/50 balance of two assets in a trading pair at all times, i.e., SOL-USDC, which is enforced by automatically rebalancing liquidity when the asset ratio diverges. For instance, assuming 1 SOL = $100, the asset balance in a SOL - USDC liquidity pool may consist of 1 SOL and 100 USDC, worth $200 total. Say the price of 1 SOL jumps to $150 - the new balance would now have to be adjusted accordingly: 1 SOL at $150 + 50 USDC. 

Providing liquidity on AMMs is a common yield farming strategy and a relatively simple concept to understand, but it is important to note that it is not risk-free and should not be treated as such. In the same way that market makers bear inventory risk by being buyers and sellers of last resort, LPs in DeFi face the risk of impermanent loss , the ultimate cost of holding assets in a liquidity pool vs simply holding them in your wallet. 

The top AMMs by TVL on Solana are Raydium and Orca, boasting $618m and $268m at the time of writing, respectively. Each of these protocols offers a number of liquidity pools, which vary by model, asset type, and fee tiers, and users are able to choose from existing pools to deposit into, or they can create their own pool as well. 

Raydium Concentrated Liquidity Pools

Raydium is an AMM-based decentralized exchange (DEX) that launched in 2022, offering swapping, liquidity provision, and yield farming services on an intuitive UI. Raydium’s latest liquidity pool model utilizes concentrated liquidity, pioneered by Uniswap V3, which enables LPs to specify an exact price range for which they would like to provide liquidity. As long as the price is in range; LPs will earn trading fees. This design was intended to be more capital-efficient than the previous AMM models, which distributed liquidity across an unbound range. 

In the ‘Concentrated Pools’ dashboard on Raydium,  users can view the liquidity, volume, and earnings per each pool and deposit into existing pools of their choice, or create new pools themselves by clicking the tab in the upper right corner.

When LPs deposit into a liquidity pool, they receive an LP token representative of their deposit amount. For example, if someone provides $1000 of liquidity into the SOL/USDC pool, they will receive a  “$1000 Raydium SOL-USDC” token. 

LP tokens can then be staked in “Farms”, enabling LPs to further generate returns with their original position. Similar to liquidity pools, users can deposit into existing farms or create new ones.

Orca Liquidity Pools 

Orca is one of the original DEXs on Solana, known for its simple and user-friendly UI and tooling. Launching in 2021, Orca enables traders to swap assets and deposit assets into various liquidity pools. Orca also utilizes a Concentrated Liquidity model, achieving higher efficiency for LPs by providing liquidity to a defined price range.  

Users can deposit liquidity on Orca through Orca’s Liquidity Terminal. 

Yield Aggregators & Liquidity Venues 

Yield aggregators are protocols that simplify the process of yield farming on behalf of users. Think of it as yield farming simplified - in the same way that DEX aggregators like Jupiter execute trades on users’ behalf, yield aggregators find the best strategies to earn yield. 

Kamino Finance Liquidity Vaults

Kamino Finance is a liquidity hub on Solana arriving in late 2022, which offers a wide range of structured yield products for users and currently holds over $1.3B in deposits. Prior to its multi-faceted product expansion, Kamino Finance’s flagship products were its automated liquidity vaults. These are smart contracts that automate the management of concentrated liquidity provision on users' behalf; this includes managing price ranges and collecting earned fees automatically to an LP’s position. 

Users can view liquidity vaults by category, asset type, TVL, volume, and APY. 

Meteora Pools 

Meteora is one of the longest-standing liquidity venues and teams on Solana, originally launching as Mercurial, a stablecoin liquidity platform, and since evolving to offer a suite of financial products for earning yield on Solana. 

Users can choose from a wide range of liquidity pools and earn yield by providing liquidity and staking their LP tokens into farms depending on the particular pool. In addition to liquidity provision services, Meteora also offers Dynamic Lending vaults, which generate yield by distributing deposited funds across top lending protocols on Solana on depositors’ behalf.

Solana LST Strategies 

Further exploring yield farming strategies, we come to liquid staking, the largest sector in DeFi at over $55B in TVL. 

Liquid staking protocols allow users to deposit a native token, e.g. SOL, to receive a liquid derivative asset equivalent in proportion to the deposit amount, e.g. JitoSOL. This design unlocks tremendous efficiency, as it allows stakers to utilize their original capital to earn an additional yield on top of their base staking yield. 

For example, users can stake SOL to receive JitoSOL, a reward-bearing LST delivering ~ 8.20% APY, which they can then deposit into a JitoSOL liquidity pool using any of the aforementioned protocols to earn LP fees on top of their original staking APY. 

Closing Remarks - Risks Involved & Important Considerations 

Yield farming is an ROI-optimizing strategy that can be carried out across one or more blockchain-native applications. However, though the innovative DeFi landscape has enabled new financial opportunities for retail users and institutions alike, it is critical to consider the risks associated with these new opportunities. 

The most common risks associated with the processes we uncovered today can be summarized as follows: 

  • Impermanent Loss - A reduction in the value of assets deposited into liquidity pools caused by price movements and pool rebalancing mechanics. This is considered impermanent because losses are only realized when an LP withdraws their deposit from a pool. 
  • Smart Contract Risk - Blockchain native applications have notoriously been targets of smart contract exploits over time, with over $5.8B in total-value-hacked in DeFi. Though most teams go through third-party audits and may or may not be open source, smart contract exploits can still occur, a critical consideration to make for anyone depositing assets into smart contracts. 
  • LST Depegs - Though rare, an LST can ‘depeg’ from its value in the event that a large amount of the LST is sold off in lower-liquidity conditions. For example, mSOL from Marinade Finance experienced a -20% deviation from its peg on December 12, 2023 after a whale sold off a large portion of stake. While LST holders do not need to react to these depegs much as the price often rebounds quickly, anyone who borrows collateral against an LST must be aware as they face liquidation risk if the price deviates significantly enough. 

Yield farming represents the evolution of financial strategies carried out on blockchain networks. These strategies iterate on established and demonstrated financial primitives, providing them through decentralized and permissionless-to-use protocols. However, as with all walks of life, greater rewards come with greater risk; those interested in participating in yield farming must take the time to understand the risks involved with these financial strategies. 

You can learn about all the ways to use JitoSOL and JTO tokens to earn additional yield on our DeFi page.

Disclaimer: None of the content in this article should be construed as financial advise. It is for information purposes only. Always do you own research.