Auto-Compound

The core function is an automated cycle that:

• Harvests accrued rewards (e.g., governance tokens, trading fees) from a liquidity pool or farm.
• Swaps the harvested rewards for the underlying LP tokens or single assets.
• Re-deposits the newly acquired assets back into the pool to earn more yield. This loop runs on a pre-defined schedule (e.g., hourly, daily) or when gas costs are favorable.

The compounding frequency—how often rewards are harvested and reinvested—directly impacts Annual Percentage Yield (APY). More frequent compounding accelerates yield growth by putting rewards to work sooner. The optimal frequency is a trade-off between gas costs for transactions and the incremental yield gained. Advanced protocols use algorithms to optimize this schedule.

Auto-compounders typically charge a performance fee (e.g., 5-20% of harvested yield) to cover gas and protocol operations. This is distinct from the underlying platform's fees. Key metrics include:

• Net APY: The yield after all fees are deducted.
• Gas Efficiency: Batching user transactions to reduce individual gas costs. Performance is transparently trackable on-chain.

Vaults accept different deposit types:

• Single-Asset Vaults: Users deposit a single token (e.g., ETH). The vault handles providing liquidity, farming, and compounding automatically.
• LP Token Vaults: Users deposit an existing LP token (e.g., UNI-V2 tokens). The vault handles the farming and compounding of the rewards earned by that LP position. This abstracts away complex DeFi interactions.

While automating returns, users inherit additional risks:

• Smart Contract Risk: Vulnerability in the auto-compounder's code.
• Strategy Risk: The underlying farming strategy may become unprofitable.
• Oracle & Impermanent Loss Risk: For LP vaults, exposure to price volatility of the paired assets.
• Gas Cost Risk: High network fees can temporarily make compounding uneconomical.

Yield Aggregator: A broader category of protocols that automate capital allocation across multiple yield-bearing strategies, of which auto-compounding is a core function. Vault: The smart contract where users deposit funds; synonymous with an auto-compounder in this context. APY vs. APR: APR (Annual Percentage Rate) assumes simple interest, while APY (Annual Percentage Yield) accounts for the effect of compounding.

An auto-compound protocol or vault automates the process of claiming and restaking yield. Instead of manually claiming staking rewards or liquidity provider (LP) fees, the protocol's smart contract performs this action on a scheduled basis (e.g., hourly, daily). The harvested rewards are swapped for more of the underlying staked assets and deposited back into the pool, increasing the user's principal and future yield potential.

The primary benefit is exponential growth via compound interest. The formula A = P(1 + r/n)^(nt) illustrates the effect, where:

• A = Final amount
• P = Principal deposit
• r = Annual interest rate (APY)
• n = Compounding frequency
• t = Time in years

Higher frequency (n) significantly boosts effective yield (APY) versus the base rate (APR). Auto-compounders maximize n by executing frequent reinvestments.

Auto-compound services charge fees for the automation and gas cost coverage. Common models include:

• Performance Fee: A percentage (e.g., 5-20%) of the harvested yield.
• Withdrawal Fee: A fee on total principal withdrawn, sometimes decreasing over time.
• Deposit Fee: Less common, a flat percentage on new deposits. These fees are deducted from yields, not principal, and are critical for evaluating net Annual Percentage Yield (APY).

For liquidity pool (LP) tokens, auto-compounding amplifies both potential returns and risks:

• Impermanent Loss (IL): The automated process continuously reinvests into the same pool, potentially compounding IL if asset prices diverge.
• Smart Contract Risk: Users delegate asset control to complex, often unaudited, vault contracts.
• Gas Cost Optimization: Protocols batch transactions to make frequent compounding economically viable, but high network fees can erode profits for small deposits.

A critical distinction in auto-compounding:

• Annual Percentage Rate (APR): The simple interest rate, assuming no compounding. This is the base reward rate.
• Annual Percentage Yield (APY): The effective annual rate, accounting for the compounding frequency. For auto-compounders, the advertised rate is almost always APY.

Example: A farm with 100% APR compounded daily yields an APY of ~171%. Auto-compounders automate this process to realize the higher APY.

Auto-compounders create complex incentive structures that can become misaligned.

• Fee extraction risk: High protocol fees or performance fees can erode yields.
• MEV (Miner/Maximal Extractable Value) risk: The predictable, frequent compounding transactions are vulnerable to sandwich attacks and frontrunning, stealing user value.
• Tokenomics risk: If the protocol uses a native token for rewards or governance, its price collapse can render the service unsustainable.

Many auto-compounders rely on admin keys or multi-sigs for critical functions like fee changes, strategy updates, or emergency pauses. This creates trust assumptions.

• A malicious or compromised admin can upgrade the contract to steal funds.
• An admin's private key loss can permanently lock funds or disable safety mechanisms.
• Timelocks and decentralized governance (DAO) mitigate but do not eliminate this risk.

Auto-compounders often interact with Automated Market Makers (AMMs) for liquidity provision, exposing users to impermanent loss. The compounding strategy itself can fail.

• Liquidity pool imbalances can make swaps for compounding inefficient or impossible.
• Gas price volatility can make frequent compounding transactions unprofitable, causing net losses for users.
• Reward token depegging (e.g., a stablecoin farm reward losing its peg) directly impacts compounded value.

Accurate price feeds are critical for calculating harvest timing, performance fees, and token swaps. Reliance on external oracles introduces risk.

• Oracle failure or delay can cause the compounder to execute at bad prices.
• Oracle manipulation (flash loan attacks) can trigger incorrect harvests or fee calculations.
• Use of decentralized oracles like Chainlink reduces but does not eliminate this single point of failure.

Auto-compounders are composability lego bricks, deeply integrated into DeFi. This creates systemic linkages.

• A failure in a major underlying protocol (e.g., a lending market insolvency) can cascade to all compounders using it.
• High Total Value Locked (TVL) in a single compounder makes it a lucrative target and a potential source of market-wide contagion if exploited.
• Liquidity crunches during market stress can lock funds or prevent timely exits.

The foundational activity that generates the rewards which are auto-compounded. Yield farming involves providing liquidity to DeFi protocols in exchange for incentive tokens or a share of transaction fees. Auto-compounding protocols automate the process of harvesting these rewards and reinvesting them back into the farm to accelerate compounding interest.

• Manual vs. Auto: Farmers must manually claim and reinvest rewards, paying gas fees each time. Auto-compounders batch this process.
• APY vs. APR: Auto-compounding turns a stated Annual Percentage Rate (APR) into a higher Annual Percentage Yield (APY) by factoring in compound frequency.

The primary source of yield for most auto-compounding strategies. A liquidity pool is a smart contract that holds pairs of tokens (e.g., ETH/USDC) to facilitate decentralized trading. Users who deposit tokens become Liquidity Providers (LPs) and earn fees.

• LP Tokens: Represent a user's share of the pool. Auto-compounders often work by staking these LP tokens in a farm.
• Impermanent Loss: A key risk for LPs that auto-compounding aims to offset by generating additional yield, though it does not eliminate the risk itself.

The core smart contract logic of an auto-compounder. A vault (or strategy) is a contract that accepts user deposits, automatically executes a yield-generating strategy, and handles the compounding cycle.

• Harvest Function: The vault's periodic call to claim accrued rewards from the underlying protocol.
• Swap & Reinvest: The vault sells harvested reward tokens for more of the underlying LP assets, then redeposits them.
• Performance Fee: Vaults typically charge a fee (e.g., 10-20% of harvested yield) for providing the automation service.

A critical variable determining the effective yield. Compounding frequency refers to how often rewards are harvested and reinvested. Higher frequency leads to a greater difference between APR and APY.

• Example: A farm with a 100% APR yields 200% APY if compounded daily, but ~261% APY if compounded hourly.
• Gas Cost Trade-off: More frequent compounding increases gas costs, which the vault's strategy must optimize against the marginal yield gain.
• Optimal Intervals: Protocols often set harvest triggers based on gas prices and accumulated reward value.

A simpler form of auto-compounding that doesn't involve LP tokens. In single-asset staking, users deposit a single token (e.g., a governance token like CRV or FXS) to earn more of that same token.

• Mechanism: The protocol mints new tokens as rewards, and the staking contract automatically adds them to the user's staked balance.
• Vote-Escrow Models: Protocols like Curve Finance use ve-tokenomics, where locking tokens for longer periods boosts rewards and voting power, with rewards auto-compounded into the locked position.