What is a Vault in Crypto?
A vault, in crypto, is a method of investing in decentralized finance products to get the highest yield.
The Long Definition
Yield-bearing vaults are a financial product in decentralized finance (DeFi). They are smart contracts that take in deposits and execute investment strategies to generate returns. These returns are then paid to the user as yield.
The vault is always looking for the best possible return for its users, so it moves funds around as needed to get the highest yield. This includes putting money into platforms like lending platforms and staking protocols.
The Purpose of Vaults in Crypto
Investing the regular way is a lot of work. You have to research and compare multiple protocols. Protocols are the basic sets of rules that allow data to be shared between computers to allow digital money to be exchanged safely.
Additionally, there are thousands of DeFi platforms. This means that researching can be a complex, time-consuming process.
As a result, vaults were created to make things easier. They automatically invest in DeFi protocols with the highest yield, ensuring that the user doesn’t have to research each and every opportunity.
However, this comes at the cost of giving up control over your investment decisions. You will also pay a fee for the service, meaning less profit. So, you’re advised to investigate a vault and compare it with alternatives before committing.
How Do Vaults Work
Vaults are smart contracts that pay a yield. They work by accepting token deposits from users and pooling them together. They then do something with the funds to generate returns. This typically involves investing in DeFi protocols that pay a yield.
These protocols can be liquidity pools, lending platforms, or staking protocols. Examples include Aave, Uniswap, and Compound.
The vault is constantly checking for the highest-yielding opportunities. So, it typically moves funds between protocols based on which one is offering the highest return.
For example, if Aave currently offers the best yield, the majority of the funds will be moved to Aave. If, in the future, Compound offers more, the majority of the funds will be moved there. This is done with the goal of maximizing returns.
When you deposit tokens in a vault, you receive yield-bearing vault tokens. These vault tokens act like an IOU that you redeem when it’s time to withdraw your funds. They represent your share of funds in the vault’s pool. They also represent your claim on the pool’s earnings.
So, in the beginning, the value of your vault tokens will be equal to that of the crypto you deposited into the vault. Over time, this value will change depending on how well the pool is performing.
The Vault Standard
DeFi is an ecosystem with different components. It is important that these different protocols integrate with one another. This is called interoperability. On Ethereum, interoperability is achieved by the use of token standards.
A token standard is a set of rules that outlines the creation of smart contracts. It’s like a general outline that smart contract developers follow. In the case of vaults, this standard is known as ERC-4626.