Yield farming has been a somewhat divisive topic in the world of crypto.
Though the yield farming explosion has died down somewhat following its Summer 2020 boom, there is still the possibility of earning an outsized yield on assets compared to that seen in the world of traditional finance. Borrowers are also able to lock up the funds in a high-interest account with ease. But those wanting to take out a loan have access to cryptocurrency with very low interest rates-sometimes as low as 1% APR. Those who are making huge returns often have a lot of capital behind them. It makes the world of taking out loans easier for all. Yield farming is important as it can help projects gain initial liquidity, but it is also useful for both lenders and borrowers. Interest rates can be volatile, making it hard to predict what your rewards could look like over the coming year-not to mention that DeFi is a riskier environment in which to place your money. Sell the rewards at a profit, and you could treat yourself-or choose to reinvest.Ĭurrently, yield farming can provide more lucrative interest than a traditional bank, but there are of course risks involved too. If you arrive early enough to adopt a new project, for example, you could generate token rewards that might rapidly shoot up in value. The main benefit of yield farming is the potential for profit. 🔗 You can create complex chains of investments by reinvesting your reward tokens into other liquidity pools, which in turn provide different reward tokens.📈 Your returns are based on the amount you invest, and the rules that the protocol is based on.💸 Another incentive to add funds to a pool could be to accumulate a token that’s not on the open market, or has low volume, by providing liquidity to a pool that rewards it.💱 Deposited funds are normally stablecoins linked to USD, such as DAI, USDT, USDC, and more.💰 Liquidity providers deposit funds into a liquidity pool.Those providing liquidity are also rewarded based on the amount of liquidity provided, so those reaping huge rewards have correspondingly huge amounts of capital behind them. It is by no means easy, and certainly not easy money. Yield farmers are often very experienced with the Ethereum network and its technicalities-and will move their funds around to different DeFi platforms in order to get the best returns. Reward tokens themselves can also be deposited in liquidity pools, and it’s common practice for people to shift their funds between different protocols to chase higher yields. Instead, lending out ETH on a decentralized non-custodial money market protocol like Aave, then receiving a reward, is yield farming.
Note that investing in ETH itself, for example, does not count as yield farming.
In return for locking up your finds in the pool, you’ll be rewarded with fees generated from the underlying DeFi platform. Once you’ve added your funds to a pool, you’ve officially become a liquidity provider. These pools power a marketplace where users can exchange, borrow, or lend tokens. The first step in yield farming involves adding funds to a liquidity pool, which are essentially smart contracts that contain funds. While this might change in future, almost all current yield farming transactions take place in the Ethereum ecosystem. Yield farming is normally carried out using ERC-20 tokens on Ethereum, with the rewards being a form of ERC-20 token.
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