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Mistracking undercounts revenue by 60%…  Why is it so hard to track DeFi's performance returns?

2021-12-08
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Why isn’t there any DeFi Wallet that offers the same experience as FTX (Blockfolio)?

FTX (Blockfolio) is a great centralized wallet that integrates currency trading, trading, custody, and asset performance tracking to price alerts quite well.

However, it’s still a centralized wallet after all. In DeFi, It's no secret that DeFi portfolios are almost impossible to be accurately tracked down. The DeFi ecosystem is in its infancy and the various public chains and protocols make our DeFi highly fragmented. Different wallets show completely different balances and asset allocations for even the same portfolio. It has become an almost impossible dream to get accurate data.

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Different wallets show completely different balances and asset allocations for even the same portfolio (From left to right: Trust Wallet, MetaMask, Ape Board, Zepper)

The return on a liquidity pool depends on three factors

The most common investment at DeFi is to participate in Yield farming, and the return you get from investing in a liquidity pool depends on three factors:

  1. Asset prices at the time of supply and withdrawal
  2. The size of the liquidity pool and the volume of transactions
  3. The incentives and bonuses offered by the liquidity pool

Compared to the two assets that provide equal value in the liquidity pool, investors may end up withdrawing a different percentage of assets than they originally pledged as the trading activity can change the price and volume of assets in the pool. Large price changes between the supply and withdrawal of either asset can result in losses compared to simply holding each asset individually in a 50:50 portfolio. This is the "impermanent loss" that has the greatest impact on investment returns when the movements of two assets are significantly unpegged.

Tracking performance on a dollar basis can be distorted

Let's start with a simple way to evaluate the return on an investment:sa

In the financial world, the cost basis is the purchase price of an asset and is often used to calculate capital gains (the difference between the cost basis and the current market value). For DeFi assets, calculating the true ROI in this way is not necessarily the best option in a bull market.

For example, what happens if you invest 10 ETH in the liquidity pool at the beginning of 2021 at $1,000 per ETH and then withdraw your investment at the end of 2021 at $4,000 per ETH? You should receive $40,000 plus the transaction fees you earned, assuming $2,000.

The cost basis of your investment is $10,000, and the capital gain is $42,000 - 10,000 = $32,000.

Now, if we're looking to determine whether or not the underlying is worth investing in, looking at capital gains may not be the best way to look at it.

In another scenario, what happens if the price of ETH drops to $900 and you only earn $450 a year in trading fees?

The value of your entire investment is $9,450 and your capital loss is $10,000 - $9,450 = $550.

If we calculate the capital gain in USD, then obviously this is a bad investment when ETH goes down, but in fact, if we take the return in ETH, you get exactly the same in both cases: 0.5 ETH.

When the price of your holdings rises sharply, your investments lose money

Before we go on to explain the difficulties of tracking DeFi performance, let's start with the simplest example of a DeFi investment:

Conditional Assumptions:

  • When investing $10,000 USD, ETH = 4412.3 USD and Stud ETH can be bought for 2.27 ETH
  • We choose a group of LPs and invest half in ETH-USDC for yield farming
  • The bull market started after we invested the money, and when it was time to redeem ETH went up by 111.9% (9350.85USD)

We entered the conditions mentioned above in this calculator:

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https://defiyield.app/advanced-impermanent-loss-calculator

The result:

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When ETH went up 111.9%

From the table, we can see that due to the yield farming, the assets originally invested in each half are heavily tilted to USDC, and if we unlock the LP Token, we can only receive 0.8 ETH and 7119.42 USDC.

If we immediately liquidate to USDC at this point, we can get

9350.85*0.8 + 7119.42 = 14600 USD

(Because the above table ignores the last two decimal places, so the specific figures are somewhat inaccurate, but this does not affect the final comparison)

If we didn't participate in DeFi investment at the beginning, then by directly realizing 2.27 ETH, we can get

9350.85*2.27 = 21226 USD

If we choose to exchange half of ETH and half of USDC but forget the LP Token, we can still get

9350.85*1.135 + 5000 = 15613 USD

If we choose to exchange half of ETH and half of USDC but forget the LP Token, we can still get

9350.85*1.135 + 5000 = 15613 USD

Although it is true that we get a high annualized return of 46% from the APY perspective, we usually ignore the performance return we can get through the HODL holding strategy alone.

The difference in performance between these two strategies is 21226-14600 = 6626 USD, which is about two-thirds of the principal amount.

When evaluating your DeFi portfolio there are only a few concerns about the return on your investment.

  • Capital gains don't show you the return on the base currency: Capital gains only tell you how much you've made or lost, but they don't tell you how much you've gained by simply holding how many tokens you've won or lost (known in the coin world as HODL).
  • Different base currencies lead to different conclusions: In the example above, you can see that if we were to simply calculate the return on ETH, we would in fact get the same result whether it was up or down. Even if the cryptocurrency market suffers a loss in dollar value, you will still have the same amount of ETH to reinvest in other assets.

It's important to decouple investment performance from the overall price movement of the market, as these small differences can greatly influence investor decisions and investment performance.

Conclusion: Technical difficulties in tracking DeFi's performance

The above scenario is relatively straightforward, as one of the assets is a stable currency. In reality, the liquidity pool can have many different variations, including multi-currency pledges and even single-currency pledges.

Therefore, keeping strict track of the price changes of the invested assets, calculating the constant losses and judging the changes in the invested assets and the chain fees is the biggest key that really affects our final returns, and here's the hard part.

  • There are multiple tokens, protocols, public chains, and commodities on DeFi. It makes DeFi more fragmented than CeFi, especially the platform coins. Because of the incompatibility of blockchain protocols, there may only be corresponding official wallets, and the assets are scattered everywhere. Once there is one missed, the account balance will be distorted.
  • The potential investment cost and miner's fee. Especially for the group LP Token, which is a waste with the current expensive handling fee. Without actuarial calculations and not enough investment capital, it is likely that the handling fee alone will eat up all the increase and reward.
  • Because most of DeFi's targets are token-based, some pledges or awards are given to Tokens or Wrapped Tokens that are not quite liquid enough in the open market, and the prices of these assets are often difficult to track.
  • If you use the APY provided by the project directly without considering the Boost condition and that these reward tokens do not necessarily have a valid price in the open market, then no matter how you calculate the number in the book, it will not be the same as the APY provided by the project. Also, the bonus tokens are not stable coins, so the APY will fluctuate constantly.
  • DeFi commodities are becoming more and more complex (e.g. DeFi 2.0). In many cases, we can't just look at the pledged revenue. Accurate calculation depends on how well you understand the commodity. For example, if you pledge ETH and CRV, the economic model behind it is completely different.
  • The mining, withdrawal, and selling of reward tokens (e.g., governance tokens): If the same pool is repeatedly reinvested at different times without monitoring the historical changes of the assets in the pool, it is almost impossible to calculate the overall performance return trend because the final total value can only be calculated from the price of the assets held in the wallet.

"You want others’ interest; they want your principal amount."

"If you don't know where your mining revenue is coming from, you're probably the mine.

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53090% annualized return rate

If we are to effectively calculate investment returns, we cannot simply look at the APY provided by the project's liquidity pool, whose formula may not be transparent and is often overly optimistic in its APY figures, and in some cases even gives an annualized rate of return which you can only see it but can’t reach it to lure those suppressed people to get on board.