A yield farm is only as healthy as the protocols it uses to maximise the assets in its vaults. Another huge part of the "VARIABLE APY" is the price/strength/consistency of the yield farms own governance token which it provides as LM on top of the yield generated to encourage more people to make use of the vaults.
Apart from making use of various token anti-dumping strategies mentioned in a previous article, yield farms can also take it a step further by enabling the governance token to mirror the price action of the native chain to remove the narrative and impression of typical "Shitcoin" price action i.e., huge pump followed by a dump. Ideally yield farms are chain agnostic and deploy on several chains. For the example below since L2 chains are the very popular among developers due to the race to win the Ethereum scaling race, I will be discussing how a yield farm can ensure price stability and mirror the movement of $ETH. This will help sustain the price of the farm/governance token so that emissions can be consistent to ensure high APY's to attract users and pull liquidity from rival farms.
A Case Study Taken from Adamant Finance (Polygon)
Assumptions:
1. Let us assume that there is a farm named "Budget Boy Finance" with Farm / Governance token "BUDJET".
2. Budget Boy Finance is deployed on an L2 chain with finality on Ethereum.
Suggestions:
Below are the most critical areas that would determine the success of Budget Boy Finance:
1. Long term staking of the BUDGET Token:
1.a. Provide voting rights and boosts on earnings like Curve Finance, i.e., if a user has 100 BUDGET then 4 years of locking would give 100 veBUDGET and max boost on earnings (BUDGET BOOST). BUDGET BOOST = amount of liquidity in vaults * No of veBUDGET
1.b. Ensure that the LM provided in the form of BUDGET has a minimum lock-in period of 3 months and an early redemption would lead to a penalty of 50% in which the slashed BUDGET gets distributed in proportion to BUDGET BOOST.
2. Highest Liquidity in vaults must be BUDGET / ETH
2.a. Allocate 50% of the LM / Inflation rewards to the BUDGET/ETH LP pool. This will incentivise more users to buy more BUDGET and ETH and hence would help BUDGET move parallel to ETH as the protocol matures. This helps BUDGET avoid "Shitcoin farm token" price action viz. "PUMP & DUMP".
2.c. This will help build the narrative among the community that Long ETH = Long BUDGET.
3. Ensure that > 30% of TVL is captured in BUDGET Staking + BUDGET/ETH Vault
3.a. This will ensure that points 1 and 2 will work out. Adamant has a TVL of $182M and ADDY staking + ADDY/ETH LP equals 30% of the TVL.
Understanding the Evolutions of Price Correlation to ETH
During the initial months ADDY < 0.3 correlation to the price action of ETH. As the protocol matured its correlation has increased by > 100% in the last month starting 1st August 2021 and ending 7th September 2021 at 0.68. As the ratio of (staked ADDY + ADDY/ETH LP):TVL increases, so will the price stability and correlation to ETH.
Below is a Chart Showing the Price Action of ADDY & ETH
You will see that it moves almost identically. During the market correction on 7 September 2021, ADDY fell by (-12.29%) and ETH by (-12.75%) which is basically mirrored price action.
Below is a log chart of the price of ADDY and ETH in terms of ETH.
