What is Yield Farming and Why It’s So Special
What the hottest money-making trend is about, how it works, who farms the best crops and why easy money is not so easy
Let’s drive in.
Yield Farming in Common Terms
Yield farming, or liquidity farming — is the process that lets you earn interest by investing your crypto in a DeFi-market. Interest can be fixed or variable.
When you take loans in usual banks using flat money, the amount is paid back with interest. Well, the essence of yield farming is the same — cryptocurrency is lent out via DeFi-protocols in order to get a return.
In simple terms you lock up holdings in smart contracts and get rewards.
The smart contract that contains all the funds — it’s liquidity pool. And once you’ve added your “money” to the pool, you become a liquidity provider (LP).
In return for providing liquidity to the pool LPs earn interest that can be generated by DeFi-platform or some other source.
Yield farming is carried out on Ethereum ecosystem, and interest paid is a form of ERC-20 tokens on Ethereum. But everything can change in the future (maybe).
Actually yield farming means lending cryptocurrency via the Ethereum network. But it’s worth noting that investing in Ethereum itself is not yield farming.
Another important letters in yield farming is TVL. It means Total Value Locked, and it measures how much crypto is locked on DeFi-lending marketplaces and other interest earning-platforms.
TVL rate shows the health of the yield farming market as a whole, and helps to compare the shares of different DeFi-protocols.
How Yield Farming Works
Yield farming is closely related to Automated Market Maker (AAM).
The first step is to choose the DeFi-platform and to deposit funds into a liquidity pool, which is basically a smart contract containing all the funds. A little reminder — after depositing you officially become a liquidity provider.
Normally you can add to the pool only stablecoins — tokens pegged to USD. The most known stablecoins are DAI, USDI, USDC, BUSD.
Liquidity pools power a marketplace where liquidity providers can lend, borrow or exchange tokens.
In return for sharing their liquidity, users are rewarded with fees generated from the platform. And of course you can deposit rewarded tokens again.
Experienced tech-savvy investors get higher yields by shifting their funds from protocol to protocol in different DeFi-platforms chasing the best results.
Anyway it’s more complicated than it looks. Those who are successful in all this farming stuff are often (always) very skilled in the Ethereum network and its technical features.
What About Yield Farming Risks
The benefit is obvious — big profit in a short time.
Yes, yield farming can bring more interest than a bank, but there are some risks.
We have to admit that the DeFi-market and its interest rates are not sustainable yet, and it’s hard to predict even over a year.
So it’s better not to leave your crypto in a DeFi yield farming system hoping to harvest a big profit in 12 months — you should monitor the environment twice a day or even more.
It is a very new technology, and there are not so many skilled specialists to hire who can develop smart contracts — so users can lose their funds because of the protocol bug.
Sometimes DeFi-market comes across scam schemes, when yield farming projects raise a huge pool and then disappear.
How Farm The Best Crop in DeFi
Yield farmers do not talk much about lending strategies because — the less people know the longer it works.
The most complicated and rewardable strategies are highly recommended for advanced users who essentially have a lot of capital to deploy. It’s important to understand that rewards are based on the amount of liquidity provided. Simply put the more you have — the more you get. But there is a chance to earn a fortune almost for free — look for new and promising projects. If you are in early enough, you can generate tokens rewards that might increase in value soon.