Profit Opportunities Possible With Polygon
In one of our first Weiss Crypto Sunday Specials, Juan Villaverde introduced us to Layer-2 (L2) solutions — protocols that sit atop the base layer blockchain to improve functionality.
In this week’s Sunday Special, Weiss crypto analyst Marija Matic breaks down a popular L2, Polygon (MATIC).
Polygon is an aggregator of different scaling solutions on the Ethereum (ETH, Tech/Adoption Grade “A”) network. As we saw earlier this year, Ethereum’s blockchain isn’t built to handle the increased volume it experienced as investors piled in. That’s where Polygon comes in. By adding scaling solutions, it allowed investors to trade ETH quickly and for a fraction of the price when others were paying well over $100 in gas fees.
But according to Marija, that’s just the tip of the iceberg when it comes to what’s possible on the Polygon network, particularly when you add in the growing decentralized finance (DeFi) revolution and the opportunity for investors to earn yields that far outperform anything in the legacy financial market.
With inflation rising and interest rates staying stagnant, high-yield investments should be at the top of every investor’s watch list. You can watch this past Weiss Crypto Sunday Special here or keep reading for the full transcript …
Chris Coney:
Hi there, guys. This is Chris Coney speaking, and welcome to another edition of the Weiss Crypto Sunday special. My guest analyst today is Marija Matic. Marija, welcome back to the Sunday Special.
Marija Matic:
Hi Chris. Thanks for having me again.
Chris:
Great to have you back. So today we're going to discuss what's possible with [the] Polygon network. Now, some of the viewers may never have heard of the Polygon network or know how it'll help them in their investing endeavors. So let's lay a bit of groundwork, and then we'll get into exactly what you can do with Polygon.
So, Juan and I previously talked about Layer-2 protocols, which Polygon is an L2 network on top of Ethereum. Give us just a quick overview of why is the Polygon network needed in the first place?
Marija:
Well, Polygon, first of all, is an aggregator of different scaling solutions on the Ethereum network. It's specifically made for scaling the Ethereum network, and the current solution, which is widely in use, is a proof-of-stake (PoS) implementation. In addition, though, Polygon will offer rollup solutions, such as ZK or optimistic rollup, and even standalone chains like enterprise chains.
So, it has a whole set of different scaling solutions made on top of Ethereum, but currently, it’s using this PoS network, which came at exactly the right time as Ethereum transactions went through the roof in the Q1 of 2021, and we were waiting for far too long to perform a transaction on Ethereum.
Chris:
Is that just because of demand?
Marija:
Yeah, because of the demand, of course.
Chris:
Okay. So it's working then?
Marija:
Yes, for Ethereum applications and their tokens and for Ethereum itself.
There were too many transactions [on the Ethereum network], and that's why the throughput was very high. And, as we all know, Ethereum is not currently scalable to cater to that kind of throughput.
Chris:
Mm-hmm. So it's reached its maximum capacity. That's a good thing because it means there is high demand for decentralized finance (DeFi), for Ethereum-based crypto technologies, etc.
I suppose, yeah, it was going to get to that point eventually; any successful product will get to that point. I always use the example of the internet and how, when it was conceived, the possibility of streaming video over the internet was just impossible to imagine. It just didn't have the infrastructure, the capacity, none of that. So the internet is actually layered as well, and that allows streaming to actually happen.
I guess we're going through that process right now: Ethereum at the base layer has been maxed out, and now we're adding these layers on top. From a user's point of view, they don't want to wait forever for a transaction to confirm. And what impact does that have on transaction fees? It pushes them right up, doesn't it?
Marija:
Yeah, yeah. I think Polygon is a neat solution, and I think it will be very interesting when they kind of develop all these different ... They're basically planning to create an internet of blockchains, to make Ethereum the central layer of all these different standalone blockchains.
Basically, they will enable Ethereum to compete with Polkadot (DOT, Tech/Adoption Grade “C”) and similar projects, and all these internet-of-blockchains projects as well. So I think it's very interesting the set of the tools they're going to offer.
Chris:
I'm with you. I remember … I think it was a book I've read by Tony Robbins because he wrote a couple of books on money and investing because he saw that people's ability to budget their money and invest it to grow their wealth was a huge area that wasn't being very well dealt with. One of the biggest takeaways from that book when I read it, he said one of the major drags on your portfolio is going to be fees and taxes — because every fee that you pay and every amount of tax you pay is money that isn't compounding or isn't making you money anymore because it has been taken out of your portfolio. The reason I think about that when it comes to Ethereum scaling and then Polygon is the fees. Where did we get to the point in the first quarter of 2021 when transaction fees were the equivalent of $50 or $250 just to get a single transaction through? Well, that is taking chunks out of your portfolio.
Every time you do $50 here, $50 there, that's $50 that you can no longer make money on. So there’s a huge incentive to save that money. So how much cheaper is it to run transactions on the Polygon network?
Marija:
Well, a normal, regular transaction, just sending from one wallet to another, I think it's around $0.00001. So four zeros.
Chris:
Okay.
Marija:
So it's very cheap, though it can be slightly more expensive when you're doing a more complicated transaction that involves a smart contract.
Chris:
I think it's 1,000 times cheaper than Ethereum.
Marija:
Yeah. I don't know. 100,000, I don't know. A lot.
Chris:
Yeah, many times. Many, many times cheaper.
Marija:
But it's interesting what you said about the compounding effect. In DeFi, Polygon has enabled larger yields on rewards because of the compounding effect, which is larger. Since you can't withdraw, you can claim the rewards like the walls and the pools. For example, multi-strategy walls or pools. They can claim rewards parts every couple of minutes, very often and reinvest those rewards into the principal and increase the amount of future rewards.
If the transactions are so cheap and very fast, like two seconds, you get these larger yields in DeFi. It's more usable in DeFi, and that's why it's currently very nice to farm on Polygon applications.
Chris:
I'm totally with you on that. Yeah. So if you were doing on Ethereum and the fees were at $50 each, well, if you'd stake some tokens or lend them out, and then you were only earning maybe $25 a week. Then, you'd have to wait for those rewards to pile up for maybe a few months and before paying the $50 transaction fee to get the money out and then reinvest it, but you could only do that every few months.
You're saying because the transactions are so cheap and so fast, it allows that process of staking and claiming rewards to happen a lot more frequently, and then it allows you to compound almost in real time.
Marija:
Yeah, it depends on the period. For example, at the peak of the roof bull run, right now, like two months ago, it was so expensive to claim the rewards or fees that you get. It was very expensive to stake or unstake your amounts, so basically it became useless for small fish.
Chris:
Right, because every transaction is hitting you for a fee.
Marija:
It is expensive. It was $200, even more to stake or unstake things while you could do that on Polygon for $0.00001.
Chris:
Right.
Marija:
So it makes a huge difference.
Chris:
It does.
Anyway, you've actually got me doing this. I won't name the service, but in one of your newsletters recently, you put us onto this yield farming platform, and I'm doing that every day — harvesting and then reinvesting.
So there are two recommendations: One was to invest in a particular asset and then the other was to farm the asset on one of these pool platforms, and because it's on Polygon, once a day I just go in, do the harvesting process and compound it for more. And then you can get these enormous yields, which is what you were recommending that we do while the market's kind of sideways. You may as well earn income from your assets when they're not going up in capital value. So that is absolutely brilliant.
Marija:
Yeah, there are many opportunities and many new platforms being built on Polygon. There are hundreds of new platforms being built on Polygon, but it's very difficult. No matter the network, even when it comes to Ethereum, you get these higher incentives, higher rewards for liquidity providing, staking or liquidity mining, but the problem is all these platforms are very new and you have to check all the audits to read the contracts, smart contracts and everything to see, which are the weaker points. And so it's quite risky.
So I would like to state that yield farming on DeFi is still a risky thing, no matter the network. And so users should be very careful and try out with small amounts and maybe stick to stablecoins while they're doing whatever they're doing in DeFi until they get kind of used to it and they learn how to do it.
Chris:
That's a good one. Learn the ropes first. I'm totally with you on that one.
Marija:
Especially when it comes to cheap networks like Polygon —mistakes are cheap. You can stake or unstake thousands of times for $1. So these kind of mistakes — if your transaction is failed, for example — aren’t going to cost you much, so you can basically experiment as it's not expensive to experiment.
Chris:
Cheap to experiment, exactly. Like if you stake in the wrong place, you just unstake again. It's a fraction of a cent, so no harm done, and it takes two seconds. So that's brilliant.
The thing that's special about the Polygon network, as far as I'm concerned, is that people say Polygon has the security of the Ethereum network. What does that mean?
Marija:
Uh, well, Polygon is not actually a real L2 solution. It's more of a commit-chain than an L2 for now. When it starts using roll-ups, it's going to become a real L2, but right now it's more of a mid-chain: It transfers some of the information to Ethereum to check pointing.
It's much safer than, for example, buying on Binance Smart Chain, which allows only 21 validators. In Polygon, anyone can become a validator. There are I think over one hundred validators at the moment.
So, basically, Polygon is an aggregator of different scaling solutions. Right now, the most popular one is a proof of stake, but optimistic roll-ups, ZK roll-ups, some standalone chains and different things will be coming. And it's going to be interesting. I can't wait to see all that and especially interoperability solutions, which they're going to build between them to communicate.
Chris:
When you say interoperability, that means where two systems communicate with each other, say two separate blockchains will talk to each other, right?
Marija:
Yes, yes.
Chris:
Got you.
Marija:
Well, they're focusing on Ethereum Virtual Machine (EVM) compatible chains, basically Ethereum-compatible chains. Yeah, it's about that.
They [also] have plasma implementation, but I'm not sure if plasma or optimistic roll-ups are going to become too popular in the future due to the seven-day rule of waiting for the money to come out of them. Based on plasma not being popular, I don't think that the optimistic roll-ups will be popular either. But we’ll have to see.
I'm also interested to see how ZK roll-ups are going to do. Hopefully, they'll do well. But we're also going to see the roll-up solution on Ethereum itself, and I'm very excited about the London fork, which will implement this new fee system for Ethereum.
Chris:
This is for Ethereum, right?
Marija:
Yes, itself. But I think Polygon will be needed even after everything happens with Ethereum — after it becomes more scalable and with higher throughput and everything, since it offers much more scalability than what is supposed to happen on Ethereum itself.
Chris:
So you just mentioned the London upgrade to Ethereum, and the big talk about this is that the network is going to start banning transaction fees instead of going to the miners, right? So the miners will still get rewarded for mining blocks, but the transaction fees themselves that you pay in Ethereum will get destroyed, reducing the amount of Ethereum in supply.
So let me just ask you a question on that: A friend of mine, a couple of days ago, was asking me if there’s a trade there. They were asking if you can buy in before something goes live, and then your chances of price going up after that is high And I said, well, not really because, I think it's already priced in, and also, it's not that exciting to begin with. The effect of banning transaction fees is going to happen very, very gradually over time. So what's your take on that? What do you think it will do to the Ethereum price?
Marija:
Well, you're right about the supply and it is happening gradually. The banning will gradually make the supply more deflationary, and we’ll feel the real effect once it becomes less inflationary.
I'm not sure on the price action because the crypto market is still very much connected to how Bitcoin behaves. Even Ethereum’s price will depend on how Bitcoin behaves until August. So it's very difficult to say if Ethereum will jump in price before that, but I wouldn't be surprised if there’s a sort of decoupling in terms of this correlation between Bitcoin and Ethereum due to the London fork. It will be very interesting to see how the network behaves once the London fork and EIP solutions are implemented. They've been truly tested on many test networks. So yeah, it will be interesting to see.
Chris:
Let’s take it back to those Polygon validators for a second.? So a Polygon validator basically is a server that is online all the time to make sure the network continues to run, and there are like a hundred of these, right? And you said that technically anyone can become a Polygon validator. Is that a money making opportunity, if I set up a polygon validator?
Marija:
I haven't been checking what the rates are for staking, but I think so far over $300 million worth of MarTech has been distributed to the validators, if I remember correctly. I mean 300 million MarTech tokens, but since they are around $1 each, so I would say maybe wrongly, but yeah, it's around $300 million. And I think around $2 billion worth of MarTech is staked. So, around $200 billion worth of MarTech is currently securing the Polygon network. That's a lot.
And there are checks and balances like validators if they're not online. If they don’t perform their duties or they act maliciously, they will be slashed. So it's not just about getting the rewards for processing the transactions and validating, it's also being responsible and non-malicious.
Chris:
Okay. Gotcha.
We’ve covered most of the types of things you can do on Polygon. There were some broad categories, like yield farming, and we talked about the compounding effect.
Then there’s liquidity mining, which you covered that in a recent newsletter. Liquidity mining can be done in two ways, right? You can use things like Uniswap (UNI) to stake two assets against each other and fees just in a normal way. But also, what I see these decentralized exchanges (DEXes) doing is, when a new asset gets listed to trade, not only do you get the fee between the two assets, but there's also a bonus token that you get. Is that how that works?
Marija:
Um, well, you're talking about the liquidity providing. So, for example, if you made a coin and you want to list it, you want it to be tradable on some centralized exchange. If you sold it to people, you probably sold it for Ethereum as a kind of initial offering, initial offer fees. You probably sold it to Ethereum, and you promised investors that you're going to lock up a certain amount of liquidity of both tokens in the pair, so Ethereum plus your own token that you made. And then you're going to create a pair, a new pair on Uniswap or another DEX, depending on which network it is, and you're going to create that pair on that decentralized exchange and lock it if you’ve promised that to the investors.
The reason being this way, they always have a certain liquidity they can trade with. If they want to sell that coin, they can sell it for Ethereum, or depending on what's in the pair or if they want to buy, they're going to have liquidity to buy. And you're not going to pull the rug out from under their feet if the liquidity is locked.
So this is liquidity providing, but not just the founders of the tokens: anyone can become a liquidity provider for existing pair on a decentralized exchange or create their own pair. You can create some very exotic pair if you think some people are going to trade it. And you are receiving rewards or seeing a portion of the fees because every trader who wants to buy or sell a certain token needs to pay a fee to the liquidity providers.
Usually, platforms collect 0.3% from the traders and they give, for example, 0.25% to liquidity providers of that pair. But it's shareable between all the people that are providing liquidity in that pool. And once you add your liquidity to that pool, you get liquidity providing (LP) tokens. They represent your share of that particular pool. And these are burnable; once you want to remove your liquidity from that pool, you give your LP tokens, and you receive your underlying tokens that you provided liquidity for. But instead, just keeping those LP tokens in your wallet doing nothing, in DeFi, there are opportunities like liquidity mining where you can reinvest those LP tokens. You can [also] lock them for certain incentives.
So, interconnectivity between all these different platforms and all these different offers presents a lot of opportunities.
Chris:
Certain pairs on these decentralized exchanges are incentivized though, aren't they?
Marija:
Yes.
Chris:
So that's what I meant by a bonus token. Like for example, there are money markets on Polygon as well, like I'm using RV, for example, and they're giving away MarTech tokens on top of the yields for lending.
So, what I wanted to ask you about that. Is that model sustainable? Because what they're doing there is if you want to incentivize the usage of a particular pool, a particular trading pair or even a particular platform, you can do something like that. You can give, say, 0.2% interest on Ethereum tokens that are deposited, but then you can say on top of that we'll give you 1% paid in MarTech tokens, right? So that effectively makes the interest rates slightly higher.
My question is, is that sustainable? What happens when the budget for that incentive runs out? The yields will drop and wouldn't that cause people to just then move on to the next most lucrative place to put their money?
Marija:
It's very, interesting and important question. They are not supposed to be sustainable. It's a market move, and people will stay on RV even after these incentives with MarTech token run out. People do need to lend and borrow their crypto, and that's primarily what these are for. And people are ready to pay for these fees for lending and interest rates, things like that. So these platforms like RV or other DeFi platforms, they offer these incentives as a way of attracting new users.
People who are doing intensive farming certainly go to higher-yield platforms, and they're going very often. When they say annual percentage yield (APY) is this high, no one is really going to stay for one year on that platform. They're going to stay maybe for one month or two, but eventually, they'll go on to another platform that offers higher yields. Especially if the platform [they’re currently on] becomes very popular in a short time because the billions get locked in. Of course, the yields are going to drop a bit. That’s what happened with QuickSwap (QUICK)
Chris:
Because they are shared more by more people.
Marija:
Right. They share the same amount of incentives among more people and more stick to money, locked money. So yeah, it's normal. It's how the DeFi functions. But there are people, we call them DeFi farmers, who are chasing the yields and tending to their yields very, very often.
Chris:
Sure. And not everyone is one of those pro users, those power users, that's constantly looking for new platforms. You said it's like a marketing strategy. It's almost like an introductory offer.
Marija:
Right. We're trying to teach our subscribers to bias. We are trying to teach them for example, how to become liquidity providers, stakers, how to use liquidity mining and other incentives. And I think it's a very important skill for the future because eventually DeFi will replace banks and doing your own investing like this in a smart way is going to be very, very important. And these are skills, these WEB3 skills are extremely important. So, I think it's very important that people are at least trying to learn these things now, and I think, for example, your courses in DeFi will help with that.
Chris:
Sure.
Marija:
I think it's very important to start now and get ahead of your peers and other people, because you will become pro in a couple of months, that's for sure, once you start doing it.
Chris:
I like your perspective on that.
You called them WEB3 skills. I hadn't thought about it like that. I mean, because I just take it for granted because we were doing it all the time. That's the hardest thing about teaching this stuff is separating out the different levels of sophistication and then teaching it in a certain order, because, in my mind, it's all just one big bucket of knowledge and I just use it whenever I need to use it. But when it comes to turning it into a teachable skill that's when I have to unpack it all.
But as you said, for the next generation, young people, it's going to be a skill they’ll need to know. In a financial system that is built on DeFi, you have to do it this way, you have to know how to put your money on deposit, to do the liquidity mining thing, whatever, otherwise your money is just going to sit there and you're going to be at a disadvantage to people that are doing it. It's interesting, that is very interesting.
Marija:
You're going to be disadvantaged. I don't think that you have to do it, at least not in our generation, but you will be disadvantaged if you don't know these things. And you're at much greater advantage if you do know. It will be quite helpful.
And especially as these DeFi applications become more secure and battle tested, in the future you’ll feel more comfortable committing more money to these applications. But right now, I think it's all about learning and maybe just moving small sums while you're learning and maybe earning a little something while doing that. I mean, of course you're going to earn something while you're doing that, but I think it's an interesting moment in history.
Chris:
I agree. And the returns are entirely scalable. You were talking about using stablecoins and putting those as a liquidity pair, for example. So if you do that with a small amount and then look at how much interest you add and calculate what interest rate you're getting, that would be the little experiment that you would do. Whatever the interest rate you work out, well that would be the same interest rate whether you stake $1,000 in QuickSwap or if stake $1 million, right? So the returns are the same, and you can calculate those based on a simple experiment, and then scale up if you want to.
Marija:
Yes. Well, if you stake or provide liquidity for a very high sum, of course your yield is going to be much, much higher.
Chris:
Yeah, I suppose. It depends on how much liquidity is already in there. If there was $1 billion of liquidity in there and you added a hundred thousand, it wouldn't make much of a difference, will it?
Marija:
It depends on the volume, actually, because traders are the ones that are paying you fees, so it's always better to provide liquidity for the pair that has lower liquidity, but higher volume. It’s kind of a ratio.
Chris:
That is a good one. So let's just make that absolutely clear, what you're talking about there is if a pair of assets with a lot of liquidity staked there, it doesn't really make any difference because that's not the basis on which you end the fee. That 0.25% fee you get is coming from a trader.
So, if a trader swaps $1,000 of assets, they don't get the full $1,000, it gets taxed a little bit. Not taxed, exactly, but the fee is taken out and given to liquidity providers, right? So that's that bit.
It's on the volume that the trader transacts. On the other side are the liquidity providers and they're receiving, so it's hard to work out what the interest rate is because it very much depends day by day on how much volume goes through that pair.
So, if you were the only liquidity providers, say, and you put a million dollars in, if $1 million of volume went through that day, you gain 0.25%. But if the next day $2 million of volume went through on that $1 million of liquidity, you gain 0.5% in that day, right? And so on. And the more it's turned over, the higher it gets. If $25 million were turned over, you'd get 2.5% in that day, and so on.
So the point, to be explicitly clear, what set me off there was you said make sure it's high-volume pools that you participate in versus large sized pools.
Marija:
Yeah, well, on the info pages of Automated Market Making (AMM) tops, you can see the ratios and how much liquidity vs. volume there is in each pair. There are also some web pages that farmers are using to analyze the profitability of each pool. But as you said, this is a changing thing.
I recently got a question from one reader who was trying to calculate everything, not because of tax purposes, but for her own purposes. And the only thing that I can say, it's extremely difficult to do if you are intensively farming or doing anything in DeFi and making lots of transactions claiming. This is extremely difficult and burdensome process, so I don't think doing it manually Is worthwhile.
Chris:
You mean trying to manually calculate your returns.
Marija:
Manually calculate all your costs, like each transaction fee. I do not really recommend it. I wouldn't do that — doing it manually for all transactions is quite impossible. Especially if you want to calculate the dollar value of a transaction fees or this or that at the moment when it happened, you have to go and have a look at how much MarTech or, I don't know, Ethereum was at that particular moment. It's horrible.
Chris:
Two things to say there: First, the way I handle the transaction fee thing is like I'll just go and buy $5 worth of MarTech, and then I'll burn through that. I mean, it'll take me forever to burn through $5 worth, but I account for $5 worth of MarTech and then gradually I'm destroying that in my portfolio by spending it. It doesn't get destroyed, but as far as my portfolio goes, that's a loss. It's a fraction of a cent here, it's a fraction of a cent there, but eventually when it all burns out then that $5 will be lost in transaction costs, right?
Marija:
That's a good thing. With Ethereum, the transactions are more expensive, but with MarTech it becomes irrelevant, really. The only people who could find it relevant are those wanting to claim small airdrops, for example, I don't know, Terra (LUNA) stakers or something like that. So when they want to claim rewards, if the sum they’re staking is very small, but they want the compounding effect and to claim them as often as possible, then they like to compare the difference between networks. But networks like Polygon are so cheap that even if you claim, I don't know, if you $100 worth of some coin daily, you will still earn more than you spent on transaction fee. So I still think it's futile to kind of go through all this mess of manually calculating everything.
Chris:
I'm with you.
The other point you made, which was a good one, was that there are certain analytics tools out there that will look at the size of liquidity pools, compare it to the volume and then give you a ratio. The problem with that is, and I think you already pointed this out, that's looking backwards, right?
Historically over the last 24 hours. What you don't know is what's going to happen tomorrow. Tomorrow there might be 10 times the volume through that pair that you're in, and all of a sudden, your earnings on that day skyrocket.
So it's not like a fixed income product or anything like that. It's totally organic. So it does make it difficult to... You know what I'm saying, but that's the beauty of it though.
Marija:
Yeah. Well, that's why I really suggest to newbies, if they have to stake or if they want to do liquidity providing, they should do it with a stablecoins, to stake on those pairs. They shouldn't really do liquidity providing with volatile pairs because there is a risk of accruement of loss and it's more complicated. They need to learn much more and to be ready to risk much more. And it's complicated. It's for seasoned liquidity providers.
I think sticking to stablecoins at the beginning would be the best option.
Chris:
Because there's sort of three levels of risk there, isn't there? You could do a stablecoin against stablecoin, you could do stablecoin against a crypto asset and then you could do crypto asset against crypto asset. And that one is the riskier, I suppose, because if you've got two ETH against 5,000 MarTech, that's fine, but then you've got the underline dollar value of both of those assets fluctuating at the same time.
At least with the second level, a stablecoin against an asset, like Ethereum against Tether (USDT), at least one of those sides is stable, as is the fee on it. But crypto asset against crypto asset, you’d really need to know what you’re doing in that scenario to avoid those assets going down in value.
Marija:
Yes.
It was shown that there were so many opportunities in DeFi and especially on the cheaper networks, like Polygon, that’s so rich right now with so many different decentralized applications. It's basically copying everything that's happening on Ethereum, but allowing for higher yields or it better returns. So I think it's a good moment for Polygon right now.
Chris:
Excellent stuff. Well, I think that's an absolute boat load of value, so we'll leave it there for now. Marija, thank you very much for being once again on the Weiss Crypto Sunday Special.
Marija:
Thank you, Chris.
Chris:
All right. That's going to do it for today's episode. Keep your eye on your inbox for next week's episode until then, it's me, Chris Coney saying bye for now.
