Beginners Guide To Stable Liquidity Pools On Planet Finance
A thorough but beginners guide to the BUSD-USDT Vault on the Blue Planet on Planet Finance.
As of writing this, the BUSD-USDT pool on the Blue Planet is yielding 93.04% annually, and a lot of people are asking how is this yield possible when on Binance.com or Crypto.com or Coinbase the best yield I can get on a stable coin (either BUSD or USDT) is about 12% per year?
What is CeFi and what is the opportunity available?
So firstly, I want to give a title to what Binance, Crypto.com and Coinbase are referred to in crypto, and that is CeFi. CeFi stands for centralized finance, and it is what everyone is used to in the normal financial world. That is where you put your money in a bank and trust the bank with it, and then the bank uses your money to make more money with it.
Looking at a normal bank further: Normally, they give you a tiny interest rate on your cash at 1% (at best) annually in the United States at the moment. And then the banks go on and use your money to make more money with other people (borrowing it), and they earn a net interest margin (NIM) on that money.
If, for example, they give you 1% interest on your deposited savings, maybe the bank will use 80% of your cash to give to people wanting to borrow money for a house at say 3%, and the remaining 20% they decide to give to credit card users and they might charge 20%. In this scenario, for basically doing nothing other than being a ‘trusted’ centralized bank and connecting a supplier (you making 1%) with various borrowers at 6.4% (((0.8*0.03)+(0.2*0.2))*100), they have made a NIM of 5.4% on the money supplied. So it is in a bank’s best interest to get as much capital as possible and pay the supplier as low as possible and make the borrower pay as high a yield as possible.
The only thing stopping banks from taking an ever-growing NIM is the competition amongst other banks. Theoretically, with the best competition globally amongst banks, the NIM will get lower, but the overheads with running a CeFi bank are huge. The biggest banks have 100’s of thousands of employees, massive brick and mortar bank locations, a slow system of moving physical and digital assets around, and a time-consuming vetting process of customers.
Now Binance, Crypto.com & Coinbase are essentially like the old school CeFi banking system. They are heavily used for onboarding and off-boarding people into and out of crypto. If you want to turn Dollars into Bitcoin, they are generally the best locations for it. But once you are in crypto, they are probably the worst places to leave your crypto to maximize your returns, and even with regards to safety (if you don’t hold your private keys, it’s not technically in your possession).
So what is DeFi and how does it differ from CeFi?
DeFi stands for decentralized finance. Essentially, every component of CeFi (from savings accounts to borrowing, buying & selling stocks, and insurance, to name a few) is conducted on two major blockchains today — the Ethereum network and the Binance smart chain.
The only difference between CeFi & DeFi is that there is no centralized party holding your money/crypto. In DeFi it is in your control, but you can allow some smart contracts to interact with your money to utilize it efficiently.
Now many smart contracts run on the two blockchains mentioned that have verifiable code (they are open source) that conducts basically all the processes of CeFi and are secured by on-chain code.
Let me give you an example to make it more clear.
When you go to Coinbase for example and you want to sell Bitcoin for USDC (the coinbase stable coin backed 1:1), there is a trading fee (that when I google the fee, coinbase charges) that is 0.5%.
So if you want to trade $100 of Bitcoin to USDC you will have to pay $0.50, and you will get $99.50 with coinbase making the fee.
In DeFi you would go to a decentralized exchange and trade your $100 of Bitcoin to USDC and pay 0.25% (currently the rate on PancakeSwap), so you would get $99.75 worth of USDC.
So the trading fee is half the price — that’s great, but who gets that trading fee, and who has the asset I want to buy? This is where something called Liquidity Pools (LP’s) are important to understand.
Liquidity Pools Explained
In DeFi the most simple LP contains two assets. The LP has two tokens with an equal amount of each token in them (in terms of US dollars). So taking the BTC and USDC example above. In DeFi we need a BTC-USDC LP to make this trade.
Let’s assume this LP exists and there is $500,000 worth of Bitcoin and $500,000 worth of USDC in the liquidity pool. Therefore it has $1,000,000 in total in the LP.
Now, if we were to buy $100 worth of USDC in this LP using the $100 of Bitcoin we had, we would get $99.75 of USDC, and the total LP would grow to be $1,000,000.25 (assuming the smart contract took no fee).
Now anyone can add or remove their amount of BTC-USDC at any time in such a liquidity pool (no know your customer (KYC) and no middlemen stopping you). So assuming I had $500,000 in the liquidity pool before this trade was made, I would have $500,000.125 after the trade is made. So all trades made in the liquidity pool go back to everyone supplying capital to it (minus any fee a platform may take).
This example above shows a tiny trade but remember billions of dollars are traded a day using DeFi LP’s, and this means the LP token grows significantly over time.
This is why a yield of at least over 20% is possible for a very long time in the right LP’s.
There are a lot of things I haven’t covered that are important, but are worth reading or watching in other documents (such as impermanent loss https://www.youtube.com/watch?v=8XJ1MSTEuU0 and how LP’s re-adjust their balances when the asset prices change inside them — https://www.youtube.com/watch?v=cizLhxSKrAc ).
So let’s move on to the BUSD-USDT LP that is currently listed on the Blue Planet on Planet Finance.
So firstly what is BUSD and USDT?
So BUSD is a stable coin made by Binance. There is literally $1USD sitting in a Binance bank account for every 1 BUSD token. This is regularly audited, and if a rich company or investor wants $1billion to trade in the crypto industry for example, they go to Binance and put a billion dollars in this bank, and then Binance mints 1billion BUSD tokens. These can be sent back at any time and redeemed for US dollars and is always 1:1. The same goes for USDT, but it is held in a bank in Hong Kong and is regularly audited also. For reference, as of writing this, there is $58 Billion US worth of USDT in circulation.
So people are constantly trading between these stable coins. When markets are bad, people sell Bitcoin to hold stable coins. When crypto markets are good, people borrow stable coins to spend instead of selling their Bitcoin, for example. But there are many more use cases than this.
As the fees are roughly half the price (0.25%) in DeFi LP’s and arguably safer as you hold the money in your wallet, many traders prefer to use DeFi (again, no KYC is required). And so the amount of trading in DeFi over CeFi will likely increase. There are already over 100 billion dollars in DeFi and Billions traded daily.
What is the BUSD-USDT LP?
The BUSD-USDT LP, is literally a pool of equal amounts of BUSD & USDT in terms of US dollars. You simply go to a site that can be used to make LP’s (such as PancakeSwap) and put the two tokens together in one transaction. As of writing this, there is currently $240million in the BUSD-USDT LP from PancakeSwap.
Once we have made or added to an LP we instantly earn an income from the LP growing due to the trading fees from people swapping tokens back and forth. In the BUSD-USDT LP it is simply people swapping BUSD for USDT and vice versa.
What about the yields that are offered above the trading fees?
If people are building LP’s using your code, you will likely get a small fee from it. In the case of PancakeSwap, the trading fee against any of their LP’s is 0.25%, and PancakeSwap take 0.05% for the platform, and 0.2% is given back to the LP. As there are multiple places that people can use to build LP’s, these platforms all compete to get users to their own.
PancakeSwap does this by giving everyone who makes LP’s on their platform the ability to stake the LP’s and earn Cake (which is their native utility token). This token has a lot of value — as of writing. Cake has a market cap of about 3Billion dollars. The market is very liquid for Cake, so when earning Cake, you can sell it immediately for any crypto on their platform or use Cake on their site for other purposes.
These rewards make everybody come back and stay with the platform.These yields will likely decrease over time, but not until the amount of capital flowing in slows down, in my opinion. As DeFi is still so early, I believe this will be a long time before reaching that equilibrium.
So going back to the BUSD-USDT LP example on PancakeSwap — Once we have made the LP (and are now eligible for a share of trading fees), we can then stake it on Pancake Swap to make some Cake interest. As of writing this, the yield is greater than 10% when just considering the Cake rewards given on top.
Note: The Binance smart chain has a block speed of 3 seconds, so you will see the cake interest grow in real-time.
So on top of the trading fees, LP providers who stake the LP on PancakeSwap also earn Cake. These two factors alone already mean we are making significantly higher yields than any CeFi platform can offer.
But there is another level to this. Cake is given to us as interest, but this interest is not compounded. The fastest way to make more interest is to have your interest reinvested efficiently.
This is where Planet Finance comes into use — As it automatically compounds the cake interest to grow the LP larger.
How does Planet Finance auto-compound the Cake interest?
On the Red Planet & the Blue Planet (and on all the vaults, except currently the BNB-AQUA & AQUA vaults), Planet Finance has created a smart contract strategy.
This strategy automatically compounds the interest received from any other site and uses the interest to buy more LP tokens for the specific pool that the interest was earned from.
This is known as an aggregator. In essence, the Red Planet and Blue Planet are primarily aggregators.
Let’s look at this further using the BUSD-USDT LP example.
So once we have made the BUSD-USDT LP token, we are now earning trading fees.
Instead of staking this LP on PancakeSwap, we go to the Blue Planet and stake it there.
So when the LP is staked on the Blue Planet, the following is happening:
Planet Finance is regularly taking the cake interest earned and splitting it into two equal amounts in terms of USD. Then with the two equal amounts of Cake, the contract sells one pile of Cake to buy BUSD and the other pile to buy USDT.
Once the BUSD & USDT have been bought, the contract then puts the BUSD & USDT together in the BUSD-USDT LP.
Once that is done, the additional LP tokens are re-staked on Planet Finance.
So think of it like this. If you had 100 BUSD-USDT LP tokens to start with after the auto-compound is done, you would have 101 BUSD-USDT (if the cake interest added up to be 1 BUSD-USDT LP). Then you will immediately get more Cake earned interest on the larger balance of 101 over 100.
Note: Currently, with this LP on Planet Finance, we go through AutoFarm before PancakeSwap to add even more interest after the PancakeSwap cake interest is paid, but I won’t explain that here as it will get too long.
AQUA earnings are paid on top of the compounded BUSD-USDT LP — Where can I learn more about AQUA?
So now we have the trading fees we earn, plus the cake interest that is auto-compounded to ensure we maximize our yield potential, and on top of that, Planet Finance rewards users on our platform by giving AQUA tokens.
To learn more about AQUA tokenomics, we recommend reading more here — https://docs.planetfinance.io/tokenomics/
To learn more about the current roadmap and AQUA future distribution of platform profits, read more here — https://planetfinanceio.medium.com/planet-finances-future-answers-to-commonly-asked-questions-f4163eb21d77