Why is the APY so high and what are the risks?
First, some definitions:
- APR represents simple interest. It is the return you'd get without compounding.
- APY represents compound interest and is computed for a given number of compounding periods n using the formula:APY = [(1 + APR/(100*n))^n-1]*100
KogeFarm auto-compounds rewards for you so, by definition, APY is a more relevant metric. KogeFarm auto-compounds at various intervals on each of our supported chains to provide the most yield to you and to make economical sense for us (since KogeFarm pays for the gas fees).
However, do not think just because you see an APY % today it will remain that way forever. There are several risks that may prevent you from getting the displayed APY in terms of actual returns:
- The value of the underlying assets may fall
The most important risk that farmers should pay attention to is the exposure to the price fluctuations of the underlying assets. Farms with a high APR tend to be minting tokens which puts downward pressure on the price. Auto-compounding helps with this to some extent, but it is not perfect. As an example, suppose we have a simple asset that earns a high APR but whose price is declining at a given rate, and consider their returns:
As the table above shows, continuous compounding helps with returns even when prices are falling. In the case of the price decline equalling -4% per day, it enables the investor to break even (ie. earn a return of 0%) while daily manual compounding will lead to a -44% loss. However, the next row shows that while auto-compounding generally increases returns relative to daily compounding, it WILL NOT PREVENT A NEAR COMPLETE LOSS OVER TIME IF PRICES WERE TO DECLINE AT A RATE OF -5%. So, please DYOR on the soundness of the underlying farms' projects before investing.
- The underlying farms' APR may also fall
Depending on the emission rate, value of underlying rewards, and liquidity in the underlying farms, the APR offered by the underlying farm may also decrease over time. This will reduce the auto-compounded APY as a result.
- Smart contract risks
There are always risks associated when interacting with smart contracts, both from us and from our underlying farms. Our exact contracts have been in use by FXS/v1 of Adamant for quite some time with no issues, and have been audited twice, so we think that our smart contract risk is low. Though, it can never be zero. When interacting with smart contracts, remember to always check that url of the website is correct to prevent scams.
- Operating risks of the underlying farm
The underlying farms tend to have substantial control over their ecosystems. There are always risks associated with either their actions or from hackers who may be able to gain ownership access to their smart contracts.