Yield farming is far from anything agricultural; it is more about earning interest in cryptocurrency. It’s like saving money somewhere, only that this time it is saving cryptocurrency to yield some amount of interest for a period of time.
Yield Farming began with DeFi in 2020 as a system that allowed investors to earn returns in annual percentages capable of reaching triple digits. However, it is risky because of the extreme volatility that comes with the market.
What is Yield Farming?
Yield farming is simply a system that allows investors to stake cryptocurrencies to help them earn passive income. When you do this, you are adding liquidity to the system and, at the same time earning rewards in the form of interest.
A real-life example is saving money in banks; all saved cash serves as a liquidity pool for the banks and can be used for lending and providing money for customers. Yield farming uses the same idea.
In yield farming, the loans are held in a smart contract that allows the borrower to put up collateral before accepting; once the loan is paid back, you gain interest on your token and farming from the platform.
Understanding How it Works
When it comes to yield farming, knowledge is key and anyone irrespective of age can participate. The first active step would be to add your funds in a liquidity pool, which can also be called smart contracts. Liquidity pool powers the entire marketplace for users to lend and exchange tokens.
Once you lock your fund in the pool, you will get rewards generated from the DeFi platform. However, yield farming involves reviving rewards on every ETH you lend on a decentralized money market protocol like Aave. The reward is often paid at a minimum threshold depending on the lending platform and the asset you chose.
The entire idea is complex stuff as it involves providing money, and those engaged in providing the liquidity will be rewarded based on the liquidity you provided.
Is It Safe?
As much as yield farming is profitable, it is not without risks. Some of the risks are:
This shows how much the investment price fluctuates in the market. You must know the costs of tokens will continue to either crash or surge.
- Impermanent Loss
This happens when you get hasty, especially when you have a huge dip. The value of cryptocurrency fluctuates greatly and sometimes when you get hasty and withdraw on time, you may become pained to see the coins experience a huge surge after a few days.
- Regulation risk
When it comes to regulation and cryptocurrency, there are a lot of practises that are questionable.
Sometimes if you are not careful, you may put your coins into fraudulent projects without noticing, which could drain all your coins in one second. For instance, fraud and misappropriation accounts were massive in 2020.
- Rug Pulls
This is one hurtful type of fraud where a cryptocurrency developer gathers funds for a project only to abandon it without returning the investors’ funds.
To avoid rug pulls, some level of due diligence is key and you can do basic rug pull screening of the token at https://rugscreen.com/
How Profitable is Yield Farming?
Just like many businesses, yield farming is risky yet profitable. There are a lot of liquidity pools that run double digits yearly APY and even thousand percentage point APYs.
However, with the high risk of impermanent risk, it can be easy to question the worth of the investments but you must know that the potential returns always upscale the risk.
Most of the time, your overall profit will always depend on the amount of cryptocurrency you have at stake.
Yield Farming Protocols/Best Platforms
There are a lot of platforms that can help you make money and optimize your coins, some of those yield farming protocols are:
- Aave – this protocol is an open-source liquidity protocol that allows you to lend and borrow crypto. You can earn interest on deposits; you can also act as depositors and borrowers by using deposited coins as collateral.
- Compound – this protocol is an open-source protocol that uses algorithms to determine the rate depositors earn on the stakes coins.
- Curve Finance – another liquidity pool that used a market-making algorithm that allows users to exchange stable coins. This protocol is a bit safer to use because the stable coin value is pegged on another medium of exchange.
- Instadapp – this one is designed for developers to help users build and manage their decentralized portfolios.
As much as yield generation is profitable, it is also very risky hence you must know the best practices that can help you succeed.
- Borrowing funds can help you earn a token as a reward and even get more tokens to borrow more.
- If your reward is more than the borrowing fees, you can use the rest to borrow to gain more rewards.
- You can lend from the highest interest rate and borrow the amount you want to in return. You can now return the remaining assets to the lending pool.
The Future of Yield Farming
When it comes to cryptocurrency it can be challenging to predict the future because of the volatility. However, the field is wide and still lucrative.
Also because of the different hype and expectations the yield farming space is getting, it can place some strain on the network which could cause some problems. If this happens it can be difficult to liquidate your assets.
Regardless, yield farming still remains a high reward practice that is worth chasing and as long as you have the right information and risk assessments you can make the best out of it.