Skip to main content
Yield in decentralized finance exists because decentralized protocols must attract and retain the resources, capital, liquidity, and operational participation, necessary for their operation. In the absence of a central intermediary or balance sheet, these systems rely entirely on voluntary contributions from participants, who must be compensated for the value they provide. The yield offered is, in effect, the price paid by the market for the services that keep the protocol functional. In liquidity provision, for example, automated market makers such as Uniswap require pools of assets to enable trading without a central order book. Liquidity providers deposit their tokens into these pools, allowing other users to swap assets instantly on-chain. Each trade generates a fee, and these fees are distributed proportionally to the liquidity providers. Without this economic incentive, participants would have little reason to immobilize their assets in a pool subject to price volatility and potential impermanent loss
What Is an Automated Market Maker? Automated Market Makers (AMMs) replaced the traditional order book with a simpler idea: liquidity pools. Instead of buyers and sellers meeting through bids and asks, traders interact directly with a pool of assets supplied by liquidity providers. Most AMMs operate under the “constant product” formula, x · y = k, which ensures that the product of the token reserves remains constant after every trade. When one side of the pool grows, the other shrinks, and prices adjust automatically. For example, in a USDC/ETH pool, a swap of USDC for ETH increases the pool’s USDC balance while reducing its ETH balance. The algorithm responds by raising the price of ETH relative to USDC, maintaining balance without the need for a central order book. Liquidity providers, in turn, earn fees from each trade, which represent their compensation for locking assets into the pool and taking on the associated risks.
In lending protocols such as Aave or Compound, the principle is similar. Borrowers pay interest to access capital, and that interest flows directly to depositors who have supplied assets to the protocol. The yield in this case is determined algorithmically, adjusting in real time to balance the supply of deposits with the demand for loans. By rewarding depositors, the protocol ensures that sufficient liquidity remains available for borrowers, maintaining the efficiency and stability of the market.
The Lending Rate Curve in Aave In lending protocols such as Aave, interest rates are determined by a utilization-based curve rather than being fixed. The utilization ratio (U) measures the share of deposited assets that are currently borrowed. At low utilization (e.g., U < 50%), borrow rates remain low to stimulate borrowing activity, and supply rates for depositors are correspondingly modest. As utilization increases, borrow rates rise, making borrowing more expensive while raising the yield for depositors. Once utilization passes a critical threshold, the “kink,” often around 90%, rates increase sharply, ensuring that liquidity remains available in the system. For lenders, this curve directly governs yield: when liquidity is scarce, supply rates climb, rewarding depositors for providing capital precisely when demand is strongest.
Yield also plays a fundamental role in network security. In proof-of-stake blockchains, validators are required to lock up tokens as collateral to participate in consensus. By producing blocks and validating transactions, they secure the network and, in return, receive rewards funded by transaction fees and, in some cases, block subsidies. Beyond these functional returns, yield is often used as a strategic tool for growth. In the early stages of a protocol’s life cycle, there may be insufficient organic activity to make participation attractive. To overcome this, protocols can issue their own governance or utility tokens as additional rewards. This practice, known as liquidity mining or yield farming, temporarily boosts returns to attract early adopters and build market depth. While effective in bootstrapping adoption, such incentive-driven yields are rarely sustainable in the long term once the protocol must rely solely on organic revenue streams. In some cases, yield compensates for more specialized contributions. Participants might earn returns for underwriting decentralized insurance, providing off-chain data through oracle networks, or executing automated liquidations of undercollateralized loans. These activities carry operational and financial risks, and yield functions as compensation for assuming them. In all these forms, yield exists in DeFi not as a marketing gimmick but as an essential mechanism for aligning incentives in a permissionless system. It ensures that the capital and services on which decentralized markets depend are supplied voluntarily, continuously, and at a scale sufficient to sustain the protocol’s operation. Without yield, the economic foundation of DeFi would weaken, liquidity would diminish, and many decentralized applications would become non-viable.