Every crypto consumer, even the most inexperienced, has come across the term DeFi, which stands for Decentralized Finance. DeFi is made up of a network of financial applications built on top of blockchains. DeFi incorporates the investor's perspective, with yield farming markets allowing them to earn returns on the valuation of their investments.
Yield farming, also known as liquidity mining, is the practise of lending cryptocurrencies in exchange for fees and interest. Yield farming follows a similar idea to when a person deposits money into a bank's savings account and collects interest.
Investing in a crypto asset isn't considered yield farming unless the lender lends out and receives interest.
Mining/Farming Yields
The key DeFi yield farming protocols are compound and aave. To mine liquidity, you must first deposit a stablecoin into either the Aave or the Compound money markets.
COMP is a token in the Compound Money Market. COMP is provided to someone who borrows or lends in the compound market. Aave, on the other hand, has higher returns than Compound because it provides borrowers with fixed rates rather than variable rates. As compared to variable rates, fixed rates have higher returns.
DeFi money markets have the added benefit of providing protection against financial risks. The over-collateralization protocols used in the money markets contribute to the high security. As a result, a borrower may need to deposit a large number of assets that are worth more than the loan amount lent.
If the collateralization ratio falls below a predetermined threshold at any time, the collateral is sold, and the lender is paid his original loan sum plus interest. Over-collateralization ensures that creditors pay the entire sum owed.
Liquidity pool
Uniswap and Balancer, as well as Curve Finance, are the three major liquidity reservoirs in DeFi ecosystems. Liquidity providers are rewarded for contributing their assets to these pools.
Uniswap can only keep two assets at a time, and each asset's proportion must be 50 percent. Balancer, on the other hand, has the benefit of allowing up to eight assets to be included in a liquidity pool, each with its own collection of ratios.
In liquidity pools, how do liquidity providers make money? Liquidity providers that contribute to the pool earn a small fee any time a person trades through it. In Uniswap, liquidity providers should accept impermanent loss if they want to increase their income. That is the price of providing liquidity for a highly volatile commodity.
Liquidity providers should set up an 80-20/90-10 allocation in Balancer to offset their impermanent loss. Providers can also gain BAL by supplying liquidity to a Balancer pool.
Curve financing also aids liquidity providers in reducing their short-term losses. This is accomplished by allowing trade between assets of the same value. One pool deals with stable coins pegged to the US dollar, while another deals with stable coins linked to Bitcoin. There is no risk of a temporary loss since the assets are worth the same amount. Curve finance reduces impermanent losses, while Uniswap and Balancer concentrate on increasing fee collection.
Yield Farming Risks
High-yielding investments are often fraught with risk. In DeFi yield mining, the situation is close. While the crypto environment is well-known, it still has a long way to go in terms of technology and growth.
Since DeFi protocols are run by smart contracts, they have the same vulnerabilities as smart contracts. Reentrancy attacks, denial of service attacks, and gas caps are only a few of the vulnerabilities that untrustworthy traders can exploit.
Another risk that has a significant impact on the crypto market is liquidation, as crypto assets will lose their value at any time.
The problem of crypto asset control is also a concern for enthusiasts. Some coins in circulation are still unregistered as shares on exchanges. A trader should be mindful of the market's risks and proceed with caution.
The crypto market's big players can easily manipulate the market, resulting in lower profits for small players. A trader may use DeFi to lend crypto and then borrow it back, resulting in a strong but fictitious demand for the coins. As a result, the market will experience unrealistic price movements.
Conclusion
Crypto enthusiasts can get returns on their assets' worth by using DeFi liquidity mining (yield farming). However, since it is still in its infancy, it has a long way to go in terms of adoption and development. While the yield fixation is entertaining, if it is not properly managed, it can cause harm in the long run.
Liquidity pools are for crypto's major whales, who are still willing to take big risks in exchange for even bigger rewards. DeFi yield farming pays a higher interest rate than fiat bank savings accounts. As a result, yield farming will continue to push crypto adoption forward.
