In our previous article we explained how is Nord Finance evolved from Slick and how are we making DeFi more accessible and user friendly for the investors.
Over the course of this 3-part article series we will explain how Nord Savings simplifies De-Fi Investing and delivers the highest risk-adjusted APY with near zero transaction fees.
Part 3 — The APY Maximization
Maximizing APYs (or returns) is a key part of DeFi (or any investment). The speed at which DeFi has gained popularity is also an indicator of the dynamic nature of DeFi yield-farming.
For reference, the chart below shows the APY for USDT and BUSD pools. Even for stable-coin based, the APY has significant fluctuations in both USDT and BUSD pools. APY fluctuations are even higher for Automated Market Maker pools (non-stable coin based pools).
USDT /BUSD Historical APYs *source curve.fi
The Farmer Saturation
A key reason why APY declines for pools which gain in popularity is Farmer Saturation. As more users join, the TVL (total value locked) for the pool increases leading to lower rewards per user.
Consider an example of a pool which generates 20 governance tokens per day. On Day 1, the pool has only 2 investors who will both be rewarded 10 pool governance tokens each. However, as the number of users increases (effectively increasing TVL) the rewards per user keep declining.
One way the APY could continue to remain high is if the pool governance tokens’ value doubled every time users doubled (or TVL doubled). However, that is highly unlikely and thus APYs are bound to decline with increasing users (and hence TVL).
Image for illustration purposes only, assumes all investors invest same amount
Nord’s APY Maximization Paradigm: Introducing Nord Savings
The Nord Savings Module is an automated tool designed to identify the best stable-coin based yield-farming strategies across blockchains. The module tracks prices, pool-wise liquidity, current & historical pool APY trends and assigns a risk-score to each strategy in real-time. Post which, the module allocates capital based on pool-wise risk-scores with the objective of delivering highest APY while following the community identified risk strategies as guard-rails.
Risk Mitigation Framework:
The Nord Savings smart contract is designed to not only maximize APY but also to adjust for risk. While a typical user operating with limited capital could only invest in 1 or 2 pools at best, Nord Savings spreads the invested funds across various yield-farming strategies. Diversification of invested capital allows the users to earn high yield, manage their risks and minimize downside due to potential smart-contract vulnerabilities.
The Nord Finance Risk Mitigation Framework leverages the DeFi Score framework. We have built our own proprietary algorithm above the DeFi score framework to deliver the highest risk-adjusted APY.
Understanding the DeFi Score Framework
The DeFi score is a framework for quantifying risk in permissionless lending pools.Originally developed by ConsenSys, the project is now open source. To account for a variety of risks present on DeFi platforms, DeFi Score assigns a rating to each protocol based on 3 key factors — Smart Contract Risk, Financial Risk and Centralization Risk.
- Smart Contract Risk — Smart contracts essentially presume the role of “intermediaries” in DeFi. While DeFi is often referred to as trustless, a user of a DeFi platform must trust the smart contract they are interacting with. Thus, DeFi Score assigns ratings to each smart contract based on Code Audit Reports being publicly available, bug bounty programs and the contracts time on mainnet.
- Financial Risk — While most lending platforms use over-collateralization to reduce credit risk, over-collateralization does not completely remove credit risk. Crypto assets are notoriously volatile and these platforms have no method to recover from system insolvency caused by volatile collateral assets. DeFi score assigns a rating to this risk based on Collateral Ratios and available Liquidity in the protocol.
- Centralization Risk — A key cause for concern in DeFi is the access of admin keys as these allow the protocol developers to change different parameters within their smart contracts. Systems such as oracles, interest rates could be adjusted or even entire funds could be withdrawn. DeFi Score assigns rankings to various protocols based on 3 key parameters — protocol administration and the type of oracles used by the protocol.
The DeFi Score framework provides a simple score with an integratable API to the Smart Contract which is used by Nord.Finance Risk Mitigation Framework to identify the protocol risk.
The Nord Finance Risk Mitigation framework is designed to poll in the relevant information from DeFi Score platform. In addition to utilizing this score, the framework is designed to make capital allocation decisions based on
- Team Background — Anonymous vs. Public Teams.
- APY Fluctuations — Daily tracker on APYs to determine fluctuations and reallocate capital.
- Protocol Integration — <5% allocation to 3rd party lending protocols to observe reliability and security prior to complete integration.
The Nord Savings Advantage:
The APY Maximization Paradigm & Risk Mitigation offers users the ability to:
- Maximize APYs in real-time across all pools where Nord Finance invests.
- Assess pool risk profiles by combining the DeFi Score Framework with Nord’s proprietary research algorithm.