What Is Yield Farming?

Yield farming is one of the DeFi investing strategies. It entails lending or staking your bitcoin coins or tokens in exchange for fees or interest on transactions. This is like earning interest on a bank account; theoretically, you are lending money to the bank. Yield farming entails transferring cryptocurrency between several markets.

Additionally, there is an aspect of yield farming in which the method gets less successful as more people become aware of it. However, yield farming is presently the primary engine of the DeFi sector's development. However, this potential gain comes with considerable risk since the protocols and currencies gained are prone to tremendous volatility and rug pulls, in which creators quit a project and steal investors' money.

How does yield forming work?

A liquidity provider donates their cryptocurrency to the DeFi network for it to run. Liquidity providers (LPs) provide cash or tokens to a decentralized application (dApp) based on smart contracts that hold all of the funds. A fee or interest generated by the DeFi platform that the liquidity pool is built on is paid out to the LPs who have locked up their tokens.

You may make money by lending out your tokens using a decentralized app (dApp) (dApp). Instead of utilizing an intermediary, smart contracts manage all of the loans.

A liquidity pool powers a marketplace where users may lend and borrow tokens. Liquidity providers that put their tickets into the pool to finance it are compensated by the fees users pay to use these markets.

Most yield farming takes occurs on the Ethereum platform. That is why the prizes are a sort of ERC-20 token.

While lenders may use the tokens as they choose, most lenders Today are speculators hunting for arbitrage chances by cashing in on the token's volatility in the market.‍

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Yield forming types

1. Liquidity provider

Users deposit two currencies to a DEX to facilitate trading liquidity. Liquidity providers get a small commission from the exchanges for each transaction. Tokens from a new liquidity pool (LP) may be used to pay this levy in specified instances.

1. Lending

Using a smart contract, holders of a cryptocurrency coin or token may lend their holdings to other individuals and collect interest on the money they leased out.

1. Borrowing

By offering one token as collateral and repaying the loan with another, farmers may borrow money. Users may then grow crops using the borrowed cash. In this approach, the farmer retains their initial holding, which may increase in value over time, while also yielding their borrowed coins. By offering one token as collateral and repaying the loan with another, farmers may borrow money. Users may then grow crops using the borrowed cash. As a result, the farmer can protect their initial investment, which may appreciate over time, while simultaneously earning interest on their borrowed money.

1. Staking

There are two forms of staking in the area of DeFi. Proof-of-stake blockchains are the most prevalent variety in which a user earns interest for committing their tokens to the network in return for network security. Staking LP tokens earned by providing liquidity to a DEX is the second option. This lets users yield twice since they are compensated for delivering liquidity in LP tokens, which they can then invest in to gain additional interest.

Risks in yield farming

Yield farming is loaded with danger. The following are just a few of the risks you run:

• Volatility

Volatility is a measurement of how much an investment's value changes over time. It's a dangerous bet since the price may swing so wildly in such a short period. While they're locked up, the value of your tokens can go up or down.

• Fraud

Profiteering by cheating the farmer of their own money is a genuine risk for crop farmers. According to a poll by CipherTrace, the overwhelming majority of the $1.9 billion in crypto crimes committed in 2020 will be attributable to fraud and misappropriation.

• Rug pulls

When a cryptocurrency developer gathers funds from investors for a project and then abandons it, this is the "rug pull" scam. The previously reported CipherTrace investigation found that over 99 percent of the primary fraud that occurred during the second part of the year was due to rug pulls. Other exit scams, which yield farmers are especially prone to.

• Smart contract risk

Intelligent contracts are vulnerable to flaws or attacks in yield farming, putting your bitcoin at risk. In Kurahashi-opinion, Sofie's "most of the risks associated with yield farming are due to the underlying smart contracts." More extensive code reviews and external audits are required to increase the contract's security.

• Impermanent loss

While your cryptocurrency is being staked, its value may rise or fall, resulting in unrecognized gains or losses. If the loss is more than the interest you received, you may have been better off if you had left your coins available to trade rather than withdrawing them.

• Regulatory uncertainty

Cryptocurrency still has several regulatory concerns to deal with, despite recent progress. The SEC has declared certain digital assets to be securities, making them subject to the agency's regulation. BlockFi, a significant crypto lending site, has already been the subject of a cease-and-desist order from government authorities.

Is yield farming profitable?

Yes, but one must put in both time and money to turn a profit. Although many high-risk techniques promise huge gains, they usually need a thorough knowledge of DeFi platforms, protocols, and sophisticated investment chains to be most successful.

Consider investing some of your cryptocurrencies in a well-known and well-respected platform or liquidity pool to see how much of a return you can expect without spending a lot of money. A solid foundation and growing confidence allow you to go on to other assets or even directly purchase tokens after that.

Popular yield farming protocols

• Curve Finance

The Curve is the most excellent DeFi platform in terms of total value locked, with approximately $19 billion on the platform. With its unique market-making algorithm, the Curve Finance platform makes better use of locked money than any other DeFi platform – a lucrative approach for swappers and liquidity sources.

There are several stablecoin pools on Curve. All of them have high APRs and are tied to fiat currency somehow. Curve keeps its APRs high, ranging from 1.9 percent (for liquid tokens) to 32 percent. Stablecoin pools are entirely secure if the tickets don't lose their peg. You may avoid impermanent loss since their expenses will not fluctuate dramatically compared to each other. Curve, like other DEXs, has the possibility of momentary loss and smart contract failure.

• Aave

Too far, approximately $14 billion worth of Aave's value has been locked up, making it one of the most commonly utilized stablecoin yield farming platforms. AAVE, the native token of Aave, is also available. This coin incentivizes users to use the network by giving fee savings and governance voting power perks.

When it comes to crop production, liquidity pools often band together. The Gemini dollar, which has a deposit APY of 6.98 percent and a borrow APY of 9.69 percent, is the highest-earning stablecoin available on Aave.

• Uniswap

Uniswap is a DEX system that permits token trades with no trust. Two tokens are needed to build a market for liquidity providers. Traders may then trade against the liquidity pool. To make their liquidity available, liquidity providers are compensated with commissions on trades made via their network.

Due to its frictionless nature, Uniswap has become one of the most popular platforms for trustless token exchanges. This is helpful for high-yield agricultural systems. UNI, the DAO governance token of Uniswap, is also available.

• PancakeSwap

PancakeSwap functions similarly to Uniswap. However, PancakeSwap runs on the Binance Smart Chain (BSC) network rather than Ethereum. It also provides a few more gamification-focused features. In addition to BSC token swaps and interest-earning staking pools, PancakeSwap also offers a gambling game in which participants must predict the future value of Binance Coin (BNB).

PancakeSwap is susceptible to the same risks as Uniswap, such as temporary loss due to substantial price changes and smart contract failure. Many of the tokens in PancakeSwap pools have low market capitalizations, placing them at risk of temporary defeat. CAKE, PancakeSwap's proprietary token, may be used to make purchases on the site and cast votes on new features.

• Compound 

Compound calculates the interest rate depositors get on staked coins using an algorithmic, autonomous interest rate protocol. Depositors also earn COMP tokens.

 Bottom line

Staking or locking up your bitcoin in exchange for interest or extra crypto is a kind of yield farming. As Bitcoin grows more popular, yield farming will become more mainstream. It's a simple principle that has been around for as long as banks have existed and is essentially a digital version of lending with interest for profit to the investors. Yield farming can create enormous income, but it is also quite hazardous. Coin price variations indicate that a lot may happen while your bitcoin is locked away.