It has always been natural to seek protection by setting money aside and keeping it safe.
More recently, with the 2008 financial crisis and the highlighting of the role of multinational banks in this economic collapse, citizens' trust in these institutions was impacted: people's desire to keep their money safe was catalyzed.
Being both fully the owner of one's crypto-assets and able to dispose of them without the intervention of a trusted third party is the principle of blockchain so I can keep my crypto in a traditional wallet or provide liquidity in an AMM, so why create a vaults ?
First of all, let's look at the difference between a vault and an ordinary wallet:
« Wallets are instantly accessible tools. The problem to their issue is that users only have their security model to protect them. If someone gets their key private, there is no recourse.
Unlike wallets, vaults offer a backup plan. They are much safer places to store crypto assets.
Cryptographic vaults are not connected to the network, so users do not have to caring about people who would like to access their funds if the linked account the safe is finally hacked.
Crypto assets stored in vaults have specific encryption methods, making them useless to attackers at unless they have specific codes.
If safety of a safe is weakening, users have a recovery mechanism. » –Ioana Alexandra Frincu How do Crypto-vaults work ?)
Safe deposit boxes are therefore particularly useful for individuals wishing to keep their assets in the long term without having to make regular transactions. They can sometimes offer tax advantages. It is also possible to create a vaults of groups.
Because of their characteristics in terms of security and composability, the vaults have quickly found their place in increasingly optimized investment strategies.
Indeed, following the rise of yield farming, the vaults offered the solution to one of the main drawbacks of yield farming: the complexity of managing its LPs (+ or - its positions of farming, more details in the article on the Yield Farming : #link#).
Indeed, it is possible to deposit one's cash in a vault and to let it collect and reinvest compound interest: that makes passive income strategies a lot more... passive!
Let us take an example, and not just any example, since we are going to talk about Yearn Finance :
« Yearn Finance is a suite of decentralized financial products (DeFi) aimed at create a simple way to generate interest through top-tier lending protocols, liquidity pools, and yield farming strategies on Ethereum.
The main advantage of yVaults is that they allow users to “deposit and forget.” The yVault will then manage everything. This includes finding the best strategy to optimize the interest received. But most importantly, perhaps, the yVault also compounds the interest. In other words, the interest received is reinvested back into your starting capital to generate interest on interest.
It is something that anyone can do themselves. You just need to claim your rewards and put them back into the protocol in question. But this takes time (you have to remember to do it) and it is not free. Indeed, you have to execute several transactions. With gas prices being quite high, it is sometimes impossible to do for users with a “small” initial capital, as transaction fees may be higher than the interest generated.
yVaults therefore make it possible to circumvent this problem since the claiming of interest and compounding is done automatically without the user having to think about it or do anything. This saves both money and time. » – Cryptouf (All about Yearn's yVaults)
«yVaults therefore bypass this problem since interest claiming and compounding are done automatically without the user having to think about it or do anything. This saves both money and time.» – Cryptouf (All about Yearn's yVaults)
The use of this type of product carries risks, and it is essential to be aware of them. Here is a non-exhaustive list:
– While deposited assets cannot decrease, the debt of a vault can decrease. If a strategy fails to outperform the debt, then a portion of the funds may be blocked. If the strategy outperforms the debt again, the assets are unblocked. There are mechanisms in vaults to achieve these blockages, but nothing is perfect.
– The vaults are audited. However, this is not a guarantee of a potential issue or hack.
- There is a risk of smart contract linked to each contract (and protocol) with which the vault interacted.
In conclusion, the vaults originally serve to store cryptos with increased security when you don't want to touch them for a while, but they also offer opportunities in numerous passive income strategies.
