Case Study: How BONK Vaults Earned Over 999% APY

High APYs can be earned from market-making yield. This report examines how Kamino's BONK vaults can sometimes display APYs above 999%.

Case Study: How BONK Vaults Earned Over 999% APY

Note: This article is not financial advice. Kamino Finance does not endorse any of the tokens or platforms mentioned in this article.

Key Takeaways:

  • Kamino's displayed APY is based on the APY reported by Orca.
  • Orca's APY is calculated based on 24h trade volume.
  • High APY reflects high short-term volume and yield earned from fees.
  • APY does not reflect performance including impermanent loss (IL).

Some APYs projected on Kamino can reach incredible heights. For example, at the time of writing, Kamino's two BONK vaults, BONK/SOL and BONK/USDH, display over 999% APY, and some users on Reddit and Twitter have claimed that this is impossible, unsustainable, and dangerous, which is far from the truth.

The two BONK vaults on Kamino have frequently displayed high APYs since launch.

This article will explain how Kamino Finance works, where the APY comes from, and how Kamino is entirely different from projects that offer yield from inflationary or otherwise mysterious sources. Hopefully, by the end of this post, users will have a better understanding of how such high yields can be achieved transparently and without ponzinomics.

Where Does the Yield on Kamino Come From?

The APY on Kamino comes from the fees users pay to make decentralized trades. Whenever someone wants to swap tokens on Orca, they have to pay a fee, and this fee goes to the liquidity providers who help users swap their tokens in and out of Orca's liquidity pools by supplying tokens for this purpose.

Any user can become a liquidity provider to earn these fees, but it's extremely difficult to manage concentrated liquidity positions as an individual. Kamino Finance manages liquidity positions on behalf of its users, and by successfully keeping positions in range and rebalancing when necessary, Kamino consistently collects fees from traders.

The process looks something like this:

  • Users deposit tokens on Kamino
  • Kamino provides liquidity on Orca DEX
  • DEX traders pay fees that Kamino collects
  • Kamino's users earn those fees

Essentially, Kamino helps users earn fees by automating and optimizing a difficult process, so anyone can participate and earn yield. As a result, the more users make trades through Orca, the more fees Kamino's users collect.

How are APYs and Yield Calculated?

APR: Annual Percentage Rate
APY: Annual Percentage Yield

The difference between an APR and an APY is compounding. If the initial position, say $100, remains $100 through the whole year, then APR is calculated. If the initial position is increased, say $10 in fees earned is added to the initial $100, then an APY is calculated.

Kamino auto-compounds fees back into liquidity positions, so an APY is calculated instead of an APR.

First of all, the APY on concentrated liquidity positions is highly variable. Depending on how narrow or wide a liquidity position is set, the estimated APR will vary, as seen below. Notice how the APR increases as the liquidity positions squeeze more tightly around the asset's current price.

Providing concentrated liquidity requires setting price ranges that affect APR.

These estimates are based on daily performance and multiplied to display a metric that has been an industry standard for years. One should never assume that the APR displayed on a liquidity pool will remain constant for an entire year, since some days will see lower and higher trade volumes.

Returns and APR are estimates based on 24h trade fees and rewards, multiplied for the year.

In addition, users should note that volatility and changes in an asset's value can affect the overall performance of a position when providing liquidity. The effects of impermanent loss are not calculated by Orca's estimated APR.  

Do Trading Fees Actually Produce >999% APY?

For the whole year, probably not. For a single day or two, though, this can happen. A 999% APY is an estimate based on the last 24 hours of trading activity. As market conditions change, so will the estimate.

The following discussion from a Reddit post about Kamino's BONK vaults sums things up nicely:

Two users on Reddit discuss the high APY on BONK vaults.

Liquidity providers earn the most fees during periods of high volume. If lots of trades are being executed, many traders are paying fees to execute those trades. In the end, Kamino can capture more fees during periods of high trade volume, and these fees are added to each user's position.

Market-making fees earned by users over a three-day period.

To reiterate, the rewards from providing liquidity depend on daily trade volume. Market makers must decide which vaults to participate in and when, based on asset quality, projected volume, and personal market outlook. Users must also factor in the effects of volatility, which can lead to impermanent loss, in addition to volume when opening a market-making position.

Impermanent loss is an inherent risk in market making, and it occurs when assets provided as liquidity diverge in value. When two assets diverge because one outperforms the other, arbitrageurs will replace the more valuable token with the less valuable token in a liquidity pool, and this needs to be factored into a market maker's bottom line when calculating fees earned from volume.

How Much Volume Can Concentrated Liquidity Facilitate?  

On one day, trade volume can be so high that pools will facilitate 5x or 13x the liquidity provided, as seen in the screenshot below from Orca taken on January 7.

Bonk vaults displayed for Orca's Whirpools on January 7, 2023.

It's noteworthy that the liquidity pool with 0.3% fees facilitated over $8 million worth of swaps with just under $650,000 worth of supplied liquidity. This is an extremely high utilization of the liquidity supplied in the pool, and the tokens concentrated around the price of BONK at this time were earning fees every time users swapped tokens at that quoted price.

These fees need to be earned by someone, and Kamino's goal is to optimize the capturing of yield from trading fees on behalf of its users. In this instance, and for several days, as can be seen in the chart recording fees earned, users were paying a large amount of fees for the ability to swap their tokens on Orca, hence the high APY—but this kind of market making activity doesn't last forever.

How Do Kamino's APY and Yield Differ from Unsustainable Projects?

In the next screenshot, taken on January 9, two days later, trade volume had decreased for the pool charging a 1% fee rate for swaps. As a result, the displayed APR was adjusted in accordance with the slowdown in trading volume.

The same Orca Whirpools on January 9, 2023.

While the APYs displayed on Orca and Kamino are incredibly high, they are based on chain data that reports real yield derived from real economic activity. Both Orca and Kamino are utilities that help facilitate decentralized trading, and users pay fees to access this utility.

This is a major difference from other kinds of yield projects that have recently failed, leaving their users high and dry. Here are a few examples of DeFi projects and primitives that have offered unsustainable APYs based on somewhat shady premises:

  • Yield Farms: After yield farming became tremendously popular in the summer of 2020, many projects began copying the model in unsustainable ways. They advertised high APYs based on inflationary rewards tokens that lost their value as users immediately swapped them for stablecoins. Users who provided liquidity in exchange for these worthless tokens became exit liquidity for project founders and early adopters.
  • Reserve Tokens: Introduced by OlympusDAO as a method for creating a new kind of token to replace or supplement stablecoins, this experiment exploded into multiple fad projects that offered high APYs for staking a toke" to "save the environment" or "start a crypto hedge fund." The system was highly dependent on new users entering the Ponzi game and staking their tokens; when the first users began unstaking and cashing out, the value of these tokens plummeted.
  • Anchor: While yield farms and reserve token ponzis were offering six-digit APYs, Anchor looked like a haven with a fixed 20% APY in return for depositing UST. Thiswasn'tasn't derived from fees earned from providing financial services. Rather, Terra Labs printed LUNA tokens, burned them to mint UST, and this eventually led to the greatest collapse of 2022.    
  • CeFi Lending: Who knows what these guys were doing, since they operated in a black box. CeFi lenders offered around 8% APY for users deposits, which attracted a risk-averse set of usersdidn'tidn't mind couldn'tldn't check what was happening on-chain, as in DeFi. Unfortunately, whatever they did behind the scenes wasn't practicing solid fundamentals, and some big-name projects became insolvent.  

BONK Reveals Market-Making Potential in Bull Markets

BONK has become one of the most actively traded tokens this year. Since traders pay a fee to liquidity providers to swap in and out of BONK on a decentralized exchange, tons of fees have been collected by liquidity providers on a daily basis while they help facilitate trades.

When calculating the fees collected in 24 hours, projected over a year, the APY for providing BONK liquidity can easily shoot up above 999%. In some cases, this means liquidity providers might be earning yields of around 20% a day—as was reported by one user on Reddit.

This is how market making can work in bull market conditions, something the DeFi community hasn't seen for a very long time. Periods of high trading volume can lead to periods of highly productive yield for liquidity providers, and this means short-term increases in APY for the users helping facilitate trade.

The goal of any successful market maker is to find high trade volume and supply liquidity during those periods. During this bear market, BONK became a visible market-making opportunity as a standout token that people want to trade despite a stagnant market. Moreover, it has provided a glimpse of what is possible during a bull.

Further Reading