6Oct 2020

Attribution Analysis & Yield Farming

by Tim Johnston

Investing in crypto assets is a fast paced job. Crypto markets move quickly and we are always on the lookout for new investment opportunities. With a wide array of investments, it is important to periodically pause and analyse how these investments have performed. Notably, it is important to analyse this at various levels, total fund performance, the performance of individual assets and the performance of the different verticals in which we invest.

With the help of Apollo’s analyst Matthew Harcourt, co-author of this article, we have dug into the portfolio’s performance to analyse the attribution of these verticals.

Return Categories

For the purpose of the this attribution analysis we are looking at four major contributors to our returns:

  • Layer 1: base layer blockchains such as Bitcoin and Ethereum. Typically we invest between 40-50% in layer one protocols.

  • Middleware: smart contract protocols built on top of one or multiple blockchains. Prominent assets include Maker, Numeraire, Synthetix. Typically we invest 40-50% in Middleware.

  • Primary Deals – new projects. Prominent assets include Algorand, Dfinity and Polkadot. Typically we invest 5-15% of the portfolio in Primary Deals.

  • Yield farming – a relatively new alpha generator which has performed exceptionally well of late. We explain yield farming in more detail below.

What is Yield Farming?

At a basic level yield farming is locking up your cryptocurrency in order to earn a yield or rewards. You earn a yield because your locked capital is providing a service, the two main services you can provide with your capital is liquidity and lending. The fund currently has part of our holdings in Ethereum and Bitcoin as well as USD stablecoins locked up in multiple pools. Without yield farming these assets would be sitting idle.

Yield farming by providing liquidity to a decentralised exchange

Decentralised exchanges (DEX) use liquidity pools to facilitate trade between users as they operate without a third party intermediary. A liquidity pool contains two or more assets and enables trading between them. The usage of a DEX incurs fees which are then paid out to the liquidity providers according to their share of the liquidity pool. The largest DEX, Uniswap, pays about $800,000 USD in fees to liquidity providers each day.

Curve DEX Example

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Over the past 4 months the annualised yields available by providing liquidity have gone from under 50% to hundreds of percent and for brief periods in excess of thousands of percent. This is because projects have provided additional incentives in the form of governance tokens to attract liquidity into certain pools. In mid June, Compound was the first DeFi platform to successfully attract liquidity by distributing their governance token and this triggered hundreds of governance tokens to flood the market over the next few months.

As yield farming matures and investors learn to accurately value governance tokens, we anticipate annualised percentage yields will drop back down to sustainable levels.

Yield farming provides the fund with a source of income that will continue to have a positive impact on the portfolio regardless of crypto asset price action. Yield farming allows us to put ‘our funds to work’, particularly Ethereum and Bitcoin that would otherwise not be earning a yield. We also use stablecoins, tokens pegged to the USD to earn a high yield on these non-volatile assets. There is of course a small trade off here, as we accept higher risk associated with the smart contracts to which we contribute funds. We balance these risks against the potential increase in returns.

Attribution Analysis

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From January to the 31st of August the Apollo Capital Fund returned 203%. The clear driver of this return was the middleware asset category. The middleware assets that the fund holds are mostly related to Decentralised Finance (DeFi), the yield farming frenzy that occurred in June, July and August caused DeFi tokens to appreciate in price dramatically. The fund has been looking at financial applications on the blockchain since its inception and believes DeFi related middleware assets will continue to attract attention and capital.

Decentralised Finance protocol’s are mostly built on Ethereum. The growth in the fund’s layer 1 crypto assets is mostly attributed to the significant increase in the price of Ethereum. Bitcoin has remained relatively stable in comparison to both Ethereum and middleware assets.

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The graph above is particularly interesting as we analyse the contribution of each vertical to monthly performance. As expected, middleware and layer 1 assets have the largest effect as they comprise the majority of the fund’s assets. The fund took full advantage of the yield farming frenzy throughout June, July and August with the passive income contributing significantly to the overall performance of the portfolio. Before June, the fund dedicated a very small amount of capital towards yield farming.

Primary assets mostly contributed very little to portfolio performance due to the small allocation and illiquid nature. However, August saw the primary asset Polkadot (DOT) surge in price as the project released their mainnet and the tokens became liquid. At its peak, Polkadot became a top 5 cryptocurrency by market capitalisation. We now consider Polkadot a layer 1 crypto asset.

Although it is not shown in the above graphs, crypto assets had an unsurprising correction in September. Throughout the month, yield farming continued to generate significant returns for the fund and was the only return category that positively contributed to the overall performance of the portfolio.

As is hopefully evident, Apollo Capital is committed to providing investors with transparent, clear information on all things crypto assets. We spend a great deal of our time thinking about how we can best communicate information about this complex asset class. We also recognise the need to provide transparent reporting on portfolio performance. We hope you enjoyed reading our attribution analysis and found it informative. We will keep investors updated as the fund progresses and as we keep up with the fast paced world of crypto assets.

This article was co-authored by Matthew Harcourt who is working as an intern at Apollo Capital during his final semester at Monash University.

Tim Johnston

Tim is the Managing Director at Apollo Crypto. He has substantial expertise in both traditional financial services and technology investing. In financial investing, he worked at DMP Asset Management, a boutique Australian Equities Fund Manager, and was part of the investment team that managed a $33 billion super fund. On the technology side, Tim has worked as a venture capital Associate at Dominet Venture Partners and has been active in crypto markets for over four years. Tim is a CFA charterholder.