Published on Oct 13, 2021

What is Yield Farming?

Parag

#Learn

7 Min

Yield farming is a method of generating additional cryptocurrency with your existing cryptocurrency. It entails you lending your money to others through the power of computer programs known as smart contracts. In exchange for your services, you will be compensated in the form of cryptocurrency.

Yield growers will employ highly complex tactics. Why? The more folks are aware of a tactic, the less successful it becomes. Yield farming is the wild west of Decentralized Finance (DeFi), with farmers competing for the opportunity to produce the finest crops.

Yield farming, also known as liquidity mining, is a method of generating rewards from crypto assets. In layman’s terms, it implies storing cryptocurrencies and receiving rewards.

In some ways, yield farming is similar to staking.

Yield farming is primarily done on Ethereum with ERC-20 tokens, and the incentives are likewise frequently in the form of an ERC-20 token. For the time being, the majority of this activity is taking place in the Ethereum ecosystem.

In order to get high yields, yield farmers would generally shift their cash around a lot between different methods. As a result, DeFi platforms may offer additional economic incentives in order to attract more money to their platform.

How does Yield Farming Work?

The initial stage in yield farming is to deposit the money into a liquidity pool, which is effectively a smart contract containing funds. These pools fuel a marketplace where users may trade, borrow or lend tokens. You’ve officially become a liquidity provider after you’ve added your cash to a pool.

You’ll be rewarded with revenue produced by the underlying DeFi technology in exchange for locking up your findings in the pool. It is important to note that investing in ETH does not qualify as yield farming. Instead, yield farming is the practice of lending out ETH on a decentralized non-custodial money market protocol like Aave and then collecting a return. Reward tokens may also be put in liquidity pools, and it's normal practice for users to move their assets across protocols in order to get greater returns.

It’s complicated. Yield farmers are frequently highly familiar with the Ethereum network and its complexities, and they will transfer their assets around to multiple DeFi platforms to maximize their profits. It’s not easy, and it’s certainly not easy money. Those who supply liquidity are likewise paid based on the quantity of liquidity given, so those who reap massive benefits have equally massive sums of money behind them.

Why is everyone talking about Yield Farming?

To put it plainly, the major advantage of yield farming is sweet, sweet profit. If you come early enough to embrace a new project, for example, you may be able to create token incentives that swiftly rise in value. You may pamper yourself or reinvest the proceeds if you sell the prizes for a profit.

Yield farming can now give more profitable income than a typical bank, but there are hazards associated as well. Interest rates can be unpredictable, making it difficult to anticipate what your returns will be in the future year—not to mention that DeFi is a riskier environment in which to invest. Yield farming is important because it may assist projects in gaining early cash, but it is also beneficial to both lenders and borrowers. It simplifies the process of obtaining loans for everyone.

Those that are generating large profits frequently have a lot of cash behind them. Those looking for a loan, on the other hand, have access to cryptocurrencies with extremely low interest rates, sometimes as low as 1% APR. Borrowers can also easily lock up the cash in a high-interest account.

Top yield farmers have made up to 100% APR on popular stable coins by employing a variety of techniques.

What is Yield Farming vs Staking?

Staking provides returns ranging from 5% to 12%, whereas yield farming provides higher APY rates. Platforms like as Uniswap, Pancake Swap, Aave, and Curve Finance provide annual percentage rates ranging from 2.5 percent to 250 percent (APR).

Farming may provide competitive profits, but it also carries greater hazards. Higher gas prices can chip away at any profit users make on APY rates. There is also the possibility of losing earnings if markets swing either bearish or positive.

Staking has certain drawbacks, including:

a) Lower APY rates.

b) The lock-in period

As stated above, the rewards on staking are a small percentage of what users may make from farm producing. Few exchanges or organizations have a lock-in period during which stakeholders are not permitted to transfer or sell their holdings. This can vary from a few months to years, and consumers risk losing their crypto assets if the market abruptly shifts from a bull market to a bear market.

To conclude, yield farming allows investors to earn significantly bigger returns than typical investments, but the higher returns come with increased risks.

What is APY?

Yield farmers, as well as the majority of protocols and platforms, estimate returns in terms of annual percentage yield (APY). The annual percentage yield (APY) is the rate of return on a given investment over the period of a year. The APY includes compounding interest, which is calculated on a regular basis and applied to the amount.

How to calculate Yield Farming returns?

This measure should be estimated annually using a yield farming calculator. It will display the potential returns over a chosen time period. Normally, two indicators, APY and APR, are sufficient, but some include a third indication, total value locked. So, here’s how you compute LP returns.

Total Value Locked (TVL) is a metric that measures how much bitcoin is locked in DeFi lending and other money markets. This indicator may be used to estimate the state of the yield farming environment.
The annual percentage rate (APR) is the amount of interest paid each year. The influence of compounding is ignored by APR.
Annual Percentage Yield (APY) is the real rate of return on investments. Compounding interest is important in this situation.

You might be wondering what compounding is. In layman’s terms, it refers to immediately reinvesting profits in order to create even more money. It is possible to use APY and APR interchangeably.

Nonetheless, calculating ROI in this sector is nearly as difficult as forecasting the outcomes of random table games like as keno or bingo. Those computations would never be completely correct. This is due to the fact that YF is a highly competitive and fast-paced market. As a result, the rewards might change in an instant. If a certain technique proves to be beneficial over a lengthy period of time, many people will adopt it. As a result, high returns may be avoided.

Is Yield Farming safe? What are the risks involved?

Yield farming, like any other business, has advantages and disadvantages. Some of them are listed below.

The liquidity risk: This hazard arises anytime the value of one’s collateral falls below the loan charge, resulting in a penalty on your collateral. Liquidation occurs when the value of collateral falls or the value of your loan increases.
Price volatility: Assume a user has gotten a lot of value from the service thanks to their YF tactics (for example, 210 percent). This person will lose since the market value of the currency has decreased. If the collateral price falls, a specialized platform will remove the borrower before they have an opportunity to pay off their loan.
Strategy threat: Assume that lending pools have been saturated as a result of decreasing liquidity. Arbitrage trading refers to the process of comparing several exchange services in order to capitalise on pricing inefficiencies. Arbitrage trading is no longer profitable if volatility falls.
Risk of a scam: Developers have authority over your currency, thus there is a risk that they will run away with it. The hazards are much larger if you do not know the developers. Participants should always ensure that the pool they have picked has been thoroughly investigated by a team they trust, although this does not completely eliminate all dangers.
Gas costs pose a risk: During the peak of the decentralized financing season, gas fees were achieved around 100 times. If they continue to rise, YF may become unattainable for most traders. ETH has launched Ethereum 2.0, which includes layer II scaling, which should address the issue of excessive gas prices. BNB, NEO, and TRON also have lower gas prices.

So there are two sides to the coin, but we feel you should take advantage of the chance and test YF, concentrating on the positives it may offer. However, in order to avoid difficulties, keep all potential hazards in mind.

Yield Farming Platforms & Protocols

Yield farmers will frequently combine a variety of DeFi protocols and platforms to maximize the returns on their staked cash. These systems provide a variety of incentivized lending and liquidity pool borrowing options. The following are some of the most widely used yield farming procedures and platforms:

Aave is an open source non-custodial decentralized lending and borrowing protocol that allows users to borrow assets and receive compound interest for lending in the form of the AAVE (formerly LEND) token.
Compound is a lending and borrowing asset money market where algorithmically adjusted compound interest rates and the governance token COMP may be earned.
Curve Finance is a DEX that uses a unique market-making algorithm to allow users and other decentralized protocols to trade stablecoins with cheap fees and little slippage. In terms of TVL, it is the biggest DEX.
Uniswap is a well-known DEX and AMM that allows users to swap nearly any ERC20 token pair without the need of middlemen. Liquidity providers must stake both sides of the liquidity pool in a 50/50 split and receive a share of transaction fees as well as the UNI governance token in exchange.
SushiSwap is a fork of Uniswap, which created quite a stir in the community during its liquidity transfer process. It has evolved into a DeFi ecosystem.
PancakeSwap is a Binance Smart Chain (BSC)-based DEX for exchanging BEP20 tokens. PancakeSwap employs an automated market maker (AMM) approach in which users trade against a pool of liquidity. It mainly emphasizes gamification aspects such as lottery, team fights, and NFT collectibles.
Venus Protocol is an algorithmic-based money market system with the goal of bringing lending and credit-based systems to the Binance Smart Chain. Venus is unique in that it may use the collateral provided to the market not only to borrow other assets, but also to mint synthetic stablecoins with over-collateralized positions that safeguard the protocol.
Instadapp is the world’s most advanced platform for using DeFi’s potential. Users may maintain and expand their DeFi portfolio, while developers can use their platform to construct DeFi infrastructure.
Balancer is a trading platform and an automated portfolio manager. Its liquidity methodology stands out due to its flexible staking. It does not compel lenders to contribute liquidity to both pools equally.
Yearn finance is an automated decentralized aggregation system that enables yield producers to maximize yield by utilizing multiple loan protocols such as Aave and Compound. Yearn.finance uses rebasing to optimize profit by algorithmically seeking the most profitable yield farming services.