People are at risk of losing their funds as they seek high yields on Ethereum.

A thread you can share with normies.

Follow-up to: https://twitter.com/tonysheng/status/1274393189231689728?s=20

Since yesterday, the conversation about "yield farming" has completely switched focus from "how" to "risk."

So if you or someone you know has put out something on risk comment it here and I'll RT at the end of this thread.

You can lose your funds in two familiar ways and one unfamiliar way.

(1) the place you stored your assets gets robbed,
(2) you borrow too much money and get liquidated
(3) the value in the asset itself gets robbed (this is the weird one)

When you lend on Ethereum, you put your assets into a vault with strict and inflexible rules. This is designed to protect you, the user. When done perfectly, even the creators of the vault cannot change the rules or tamper with the money inside of it.

How can your assets get robbed if they're in a magical internet vault that nobody can tamper with? Turns out, crafting these vaults is difficult (and a relatively new trade).

If there is a vulnerability in the vault, your funds are at risk. Vulnerabilities are found relatively frequently and even experts can miss them. So this is a real risk and one that's difficult to gauge.

How can you manage this risk?

Insurance providers are starting to come online like @opyn_ and @NexusMutual but it is still early. It's almost impossible to 100% manage this risk toiday.

The second way you can lose your money is by borrowing too much.

To maximize yield, some people are borrowing up to four times their initial deposit.

If the value of your deposit dips below the required amount you need to borrow, then you run the risk of getting liquidated.

When you get liquidated, your deposits are sold to cover the value of what you borrowed.

You also get charged a penalty that can be severe. Leverage is scary. Approach with caution.

How can you manage this risk?

Don't take on too much leverage (don't touch it at all if you can avoid it). This risk isn't unique to crypto.

The third way you can lose your money—your value in the asset itself gets robbed—is hardest to explain.

The best metaphor I can come up with is this: imagine each US dollar bill contained $1 worth of gold. Everybody that uses dollars knows and expects this to be true.

One day, someone realizes that it's actually only $0.50 in each dollar.

Now all of your dollars are worth half the price.

This form of robbing—your asset being undercollateralized—could actually happen with fiat-backed digital dollars like USDT and USDC.

There are other ways the value could be robbed from your assets but that's out of scope for this thread.

Finally, there's the more subtle risk of the entire system failing somehow.

Because so much of the system is connected, a failure at one point can lead to failures in other seemingly unrelated places.

This too is out of scope for this thread.

All this to say, there are material risks and everybody should proceed with caution, especially those unfamiliar with any of the topics in this thread.

Remember that returns are a function of risk.

High returns are almost always correlated with high risks.

Whether the risk is worth the reward is for you to decide.