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What is yield farming?

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Written by   145
1 month ago

Yield farming simply refers to using your crypto to generate more crypto.

It involves lending or making your crypto accessible to other market participants for the benefit of earning returns.

Yield farming is currently the fastest growing subsector of the DeFi economy and it is believed that there's still so much room for it to keep growing.

Types of yield farming

There're basically three types of yield farming.

  1. Lending

  2. Liquidity mining

  3. Staking

Let's briefly examine each of the above below.

1. Lending

Lending is the act of making your coins or token available for others to use for a regular fixed or flexible interest.

Crypto lending works similar to lending in the traditional financial system.

How're in crypto, there are centralized (e.g Nexo, Celsius) and decentralized (e.g Venus protocol, Compound finance) lending platforms that pay interest on your deposited crypto.

These platforms lend out your deposited crypto to the individual or institutional borrowers who need funds to finance their operations and share their profits with you.

In fact, the lenders on these platforms usually receive 70% to 90% of the profit while the platform keeps the rest to off-set floating cost.

One interesting thing is that with crypto lending, you can actually spend your coins or tokens without selling them.

How?

By borrowing against your deposited cryptocurrency.

For details on how this works, read my previous post, How to spend your crypto without selling it.

2. Liquidity Mining

Liquidity mining became popular with the growth of decentralized exchanges and automated market-making (AMMs) platforms.

Unlike centralized exchanges where hundreds of thousands and millions of traders buy and sell directly with one another, on AMMs you buy and sell directly with a smart contract.

Users (you) provide liquidity into a pool, says ETH/PRE pool by depositing an equal amount of both ETH and the PRE token.

When traders buy and sell PRE, the trade is executed from the balance of this pool and the tokens balances and price will be automatically adjusted accordingly by the smart contract.

Users who provide liquidity into the pools earn what's called a liquidity providers (LPs) fee.

And at any time, you can remove your liquidity from the pool(s) and claim all the LP fees you have accumulated.

3. Staking

Staking is probably the first popularised yield farming operation.

In staking individuals or organisations commit their cryptocurrencies for the security of a proof of stake (PoS) blockchain for the benefit of earning rewards.

Staking is similar to mining, where you use specialised machines to produce new coins.

However, unlike mining which requires the use of expensive machines and complicated setups, staking only requires that you lockup a sufficient amount of the same cryptocurrency and get rewarded with more of that token.

Usually, the locked-up funds entitle participants to verify transactions of the blockchain and participate in the governance operations of the network.

The returns for locking up your funds on a PoS blockchain is called "staking rewards".

Unlike liquidity mining where your rewards are only accessible when you remove liquidity from the pool, in staking, you can spend your rewards as you receive them.

There're flexible and fixed taking.

In flexible staking, you can remove the original capital at any time and you will have access to it immediately.

Fixed staking, on the other hand, requires that you stake your cryptocurrency for a specific period of time.

And it is impossible to withdraw your capital before that time expires. However, you can claim and spend the rewards.

The risks of yield farming

Everything in life has some elements of risk and yield farming is no different.

The major risks associated with yield farming are impermanent loss, scams, and failed project.

Impermanent loss

Impermanent loss occurs when one of the tokens you deposited into the liquidity pool loses value against the other. And it is mostly associated with liquidity mining.

TO understand impermanent loss properly, please watch this video below by Finematics.

Scams and failed projects

Some projects are outright scams while others will become failed businesses due to one or more of many reasons.

Usually, yield farming projects teams are anonymous.

Meaning that there's no human identity behind these projects. Which empowers the bad actors to come in, steal your money and walk away untraceable.

You also stand to lose a lot of money if a project you invested in fails for any reason, such as hack, unsustainable business model, poor team, competition, etc.

Usually, this will be reflected by a collapse of the coin's price. Thus leaving you with worthless tokens.

Conclusion

Buying and just HODLing your crypto is an amateur crypto investment strategy.

You should put any crypto you have to work for you while you're holding with the expectation that the price will pump.

That way, you not only enjoy the profit from any potential price increase, but the amount of the coin or token you have will grow as well.

Thus helping you build up your crypto wealth more quickly.

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Comments

Very informative 👌👍 thanks a lot

$ 0.00
4 weeks ago

Yield farming is the practice of staking or lending crypto assets in order to generate high returns or rewards in the form of additional cryptocurrency. This innovative yet risky and volatile application of decentralized finance (DeFi) has skyrocketed in popularity recently thanks to further innovations like liquidity mining. Yield farming is currently the biggest growth driver of the still-nascent DeFi sector, helping it to balloon from a market cap of $500 million to $10 billion in 2020.

In short, yield farming protocols incentivize liquidity providers (LP) to stake or lock up their crypto assets in a smart contract-based liquidity pool. These incentives can be a percentage of transaction fees, interest from lenders or a governance token (see liquidity mining below). These returns are expressed as an annual percentage yield (APY). As more investors add funds to the related liquidity pool, the value of the issued returns rise in value.

At first, most yield farmers staked well-known stablecoins USDT, DAI and USDC. However, the most popular DeFi protocols now operate on the Ethereum network and offer governance tokens for so-called liquidity mining.

Liquidity mining occurs when a yield farming participant earns token rewards as additional compensation, and came to prominence after Compound started issuing the skyrocketing COMP, its governance token, to its platform users.

Most yield farming protocols now reward liquidity providers with governance tokens, which can usually be traded on both centralized exchanges like Binance and decentralized exchanges such as Uniswap

$ 0.00
1 month ago

This is an interesting article for a NOOB like me. Thanks.

$ 0.00
1 month ago

true

$ 0.00
1 month ago

Ok actually I gave an account already but don't know how to use it

$ 0.00
1 month ago