TL;DR: CAKE is indeed inflationary, but much less so than fiat. PancakeSwap appears to look solid long term, but as anything on BSC, it hinges on Binance not engaging in game breaking shenanigans.
1. PancakeSwap is no doubt the most popular DeFi platform on the Binance Smart Chain(BSC) right now, but their pools and reward schemes present APRs that may seem a little too good to be true. In this post, I will try to explain how PancakeSwap could remain profitable, and how it could collapse entirely. This is not a shill post, and of course it is not financial advice either. If you already know how PancakeSwap works, you could skip right to the 7th paragraph.
2. First, to understand the gist of how PancakeSwap works, we will take a brief look at its history. It started as a Uniswap clone on BSC, which means an AMM platform where people can provide their assets as liquidity in return for a portion of the trading fees. However, PancakeSwap goes one step further, and provides staking pools and yield farms. They have also been adding more features later on, like a BNB price prediction game, and a lottery, slowly building themselves somewhat of a casino. They have their own token called CAKE.
3. It feels a bit weird to call the PancakeSwap staking pool “staking”, but I will roll with that terminology for lack of a better word. With occasional exceptions, the staking pools on PancakeSwap let you lock up your CAKE in return for more CAKE, or some other token. The CAKE to CAKE pools are fed CAKE from the minting cycle, and are therefore eternal. The CAKE to TokenX pools are temporary, because they need an external source of TokenX. So, when the pool runs out of tokens to reward the stakers, the fun is over. This post is mostly concerned with the CAKE to CAKE pools, because these tie directly into the CAKE tokenomics. I mentioned there is minting of CAKE, and indeed there is. On every block, which for the BSC means every 3 seconds, 40 new CAKE is minted. Looking a bit at that number, our old friend DOGE comes to mind, but I would like to emphasise that both DOGE, and here CAKE, mint a static amount of new tokens per period of time, which means inflation rates decrease over the long run, as opposed to fiat where they just pump harder and harder to keep their rates up. Additionally, most of this freshly minted CAKE actually does not even enter circulation. At the time of writing, 10/40 goes to the staking pools, 9/40 goes to the farms, and the rest is burnt.
4. Apart from the staking pools we also need to consider the farms. Farms also reward CAKE, but you need specific LP tokens to stake in them. These LP tokens are the ones you get when you provide liquidity to a trading pair. Important to note here is that when you provide liquidity you also get a portion of the trading fees. The trading fees are paid in whichever tokens you provided, and work completely separate from the farms. Not all token pairs have a farm, and some farms are only temporary, so apart from the impermanent loss that everyone is warning you about, some additional care is required when choosing which pair to provide liquidity for on PancakeSwap.
5. To summarize, PancakeSwap provides two ways to earn passive income. Just like Uniswap, you can lock a pair of tokens in a liquidity pool to earn trading fees, rewarded in those tokens. Additionally, you can stake the LP tokens you get when providing liquidity in a farm for additional rewards in CAKE. You can also stake CAKE in various pools for more CAKE, or some other token. But, doesn’t this just cause massive inflation in CAKE you say? Yes, indeed it does, and that is exactly what we want to look closer at next.
6. To prevent hyperinflation of CAKE, PancakeSwap performs token burns, i.e. they remove CAKE tokens from circulation every week. To do this, they need to gather CAKE from the end users, which is naturally done through fees. Part of the trading fee that users pay when using the DEX is used to burn CAKE. This is also where the casino comes in. Through the casino, PancakeSwap generates fees that can be used to burn CAKE. When the fee is collected in CAKE it is simply burnt, but when the fee is collected in some other token they do what they call “buyback and burn”. Pretty self explanatory, but that just means they use whatever token they collected in fees to buy CAKE from the market, and then burn it. I only have a BBA, so what do I know, but my hunch is that this “buyback and burn” is rather effective because not only does the burn reduce supply, the buyback also generates artificial demand. However, this is the kind of system that only works as long as it works, so let’s remember to consider how it could stop working.
7. The most obvious threat to PancakeSwap is something happening to Binance. There is not really that much for us to do about that though, so I will just recommend everyone who keeps funds on BSC to have an escape plan that does not involve the Binance bridge. It is a rather unlikely scenario, but the consequences could be massive. Then there are hacks, rugpulls, or anything else that would ruin their reputation, but this is the same for pretty much any project.
8. Second, given the burn mechanism I explained above(6), PancakeSwap is reliant on keeping platform traffic up to keep inflation down. If the bear market hits and traffic drops substantially, the inflation could spike. With the market already on a downwards trend that could get nasty.
9. Finally, CAKE as a token really only has one use, yielding more crypto. It also works as a governance token, but that is more of a secondary utility. Due to the way CAKE minting works(3) the APR on the pools is steadily creeping downwards along with the gross inflation rate. This makes staking CAKE seem like sort of a prisoner’s dilemma. A krill like me is not going to make a difference, but imagine a pancake whale suddenly deciding the APR has dropped too low, and deciding to dump his CAKE. This would of course cause the APR to rise back up, but if the price suddenly dumped notably this could cause FUD and panic selling, further dumping the price to a point where it is not able to recover.
10. In conclusion, PancakeSwap might not qualify as a ponzi, because your profit is not so much from the investors coming after you, but mostly from the users of the DEX, or the casino, both of which are legit products. In fact, the more value is invested in a pool the lower the APR gets, so from a yield perspective we would prefer people to burn all their CAKE on the lottery.
11. If I have to make predictions, I would say that PancakeSwap is going to survive a bear market, if only because it is by far the biggest DEX on BSC right now. The price of CAKE will drop more than the average top 50 coin, but not so much that the pool APRs cannot compensate for the difference. They will see a new ATH at roughly the same time as BNB during the next bull run. Now I just need to wait 4 years to see how well these predictions are going to age.
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