The yield model of defi is broken – this is how we fix it

Opinion: Marc Boiron, Chief Executive Officer of Polygon Labs

Decentralized Finance (DEFI) requires a reality check. The protocol has chased growth through token emissions that promise eye-opening annual yield (APY) over the years, but we can only see liquidity evaporating when incentives deplete. The current state of Defi is driven too by the mercenary capital, creating an artificial ecosystem that is doomed to collapse.

The industry is caught up in a disruptive cycle. Start a governance token, generously distribute it to liquidity providers, raise locked totals (TVL), celebrate growth indicators, and watch farmers without help as they withdraw capital and move to the next hot protocol. This model does not build enduring value – it creates a temporary illusion of success.

Defi deserves a better approach to value and capital efficiency. Current emission-driven yield models have three fatal flaws that undermine the industry's potential.

Inflation emissions

Most of Defi's yields come from inflation token emissions, not sustainable revenue. If the protocol distributes native tokens as rewards, it dilutes the token value to subsidize short-term growth. This creates an unsustainable dynamic that extracts value from the early participants and extracts later users as holding devalued assets.

Capital Flight

The mercenary capital controls the fluidity of definitions. Without structural incentives for long-term commitments, capital is free to move towards protocols that provide the highest temporary yield. This fluidity is not faithful. Following an opportunistic path rather than a fundamental value, the protocol is vulnerable to sudden capital flights.

False incentives

False incentives prevent protocols from building sustainable finances. When governance tokens are used primarily to attract liquidity through emissions, the protocol fails to acquire its own value, making long-term development and security investment impossible.

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These problems are repeated over and over multiple definition cycles. The “Summer Summer” of 2020, the yield agriculture boom in 2021 and the subsequent crashes all show the same pattern. Unsustainable growth follows catastrophic contractions.

Protocol Owner's Liquidity

How can I fix this? This solution requires a transition from extracts to regenerative economic models, and the liquidity of protocol ownership is one of the most promising approaches to solving this problem. Rather than renting liquidity through emissions, the protocol can build a lasting capital base that generates sustainable returns.

Having a protocol owns liquidity has multiple benefits. They will begin to resist capital flight during the market slump. They can generate consistent fee revenues back to the protocol rather than temporary liquidity providers. Most importantly, it can generate sustainable yields derived from actual economic activity rather than token inflation.

Use bridged assets to generate yields

Bridging assets provide another path to sustainability. Typically, bridged assets just sit there and don't contribute much to the liquidity potential of connected blockchains. By staking the bridge, the bridge's assets are relocated to Ethereum's low-risk harvest strategy, which is used to increase yields. This allows the protocol to tailor participants' incentives to long-term health conditions, boosting capital efficiency.

For Defi to mature, the protocol must prioritize the actual yield. It's a return generated from actual revenue, not from token emissions. This means developing products and services that create authentic user value and capture some of that value of the protocol and its long-term stakeholders.

Sustainable yield models typically produce lower initial returns than emissions-based approaches, but these returns are sustainable. Protocols employing this shift build a resilient foundation rather than chasing vanity metrics.

An alternative is to continue the boom-and-bust cycle that undermines reliability and prevents mainstream adoption. Defi can't fulfill its promise to revolutionize finance, relying on an unsustainable economic model.

Protocols that do this accumulate a Treasury Ministry designed to weather the market cycle rather than dry up during a recession. Rather than printing tokens, it generates yields from providing real utility.

This evolution requires a collective change in thinking from Defi participants. Investors need to recognize the difference between sustainable and unsustainable yields. Builders need to design talk nemics that reward long-term integrity rather than short-term speculation. Users need to understand the true source of returns.

The future of Defi relies on getting these basics right. It's time to fix the broken yield model before repeating past mistakes.

Opinion: Marc Boiron, CEO of Polygon Labs.

This article is for general informational purposes and is not intended to be considered legal or investment advice, and should not be done. The views, thoughts and opinions expressed here are the authors alone and do not necessarily reflect or express Cointregraph's views and opinions.