Decentralized finance has become an important part of cryptocurrencies, and yield farming is one of the main ways to make money in this segment of the crypto market. This blog post will explore yield farming and its specifics. We will cover the basics of yield farming and then dive into the ways you can make a profit from it. There are different ways to get involved in yield farming, and we will discuss some of the most popular platforms and strategies. So, whether you are only starting or are looking for new ways to increase your profits, this blog post has something for you!
What is yield farming?
Yield farming is a type of earning interest on your cryptocurrency holdings. In the past, it was done by simply holding your coins in a wallet or on an exchange that paid interest. However, yield farming has become much more popular in recent years thanks to the rise of decentralized finance (DeFi).
DeFi is a category of financial applications that are built on top of the Ethereum blockchain. These apps allow users to borrow and lend money, trade cryptocurrencies and earn interest on their holdings.
Yield farming is a set of tools and methods that allow you to make a profit on digital assets using decentralized protocols. To put it simply, DeFi users rent out their coins or tokens, for which they receive rewards as established by the protocol.
The first yield farming platforms appeared in early 2020. The protocols they used, such as Compound and Maker, had been around for a while but were not widely used. That changed when a new crop of yield farming protocols, such as Balancer and Curve, launched. These new protocols offered higher rewards than the existing ones, leading to a wave of users migrating.
The popularity of yield farming protocols exploded in the summer of 2020. This was due to the launch of several new protocols, such as Synthetix and yearn.finance, as well as a surge in the price of Ethereum. The high gas prices on Ethereum made it challenging to use many DeFi protocols, so users began to move to other blockchains, such as Binance Smart Chain and Polkadot. This led to a new wave of yield farming protocols launching on these blockchains.
How does yield farming work?
Yield farming protocols typically have two components: a liquidity pool and a reward system. The liquidity pool provides liquidity to the protocol and is usually made up of a mix of cryptocurrencies. The reward system is used to incentivize users to provide liquidity to the pool and can take many different forms.
The most common type of reward is an interest rate. This is paid to users who deposit their cryptocurrency into the liquidity pool. The interest rate is usually variable and depends on the amount of liquidity in the pool. The higher the liquidity, the lower the interest rate.
Another type of reward is a staking bonus. This is paid to users who lock their cryptocurrency up in the protocol for a certain period of time. The longer the lock-up period, the higher the staking bonus.
Types of yield farming
There are two main types of yield farms: liquidity pool (LP) and staking. Both of these involve users depositing cryptocurrency into smart contracts, but they differ in the type of smart contract.
LP farms: A user deposits cryptocurrency into a smart contract that functions as a decentralized trading pair between two, or sometimes more, cryptocurrencies. This is made possible by the Automated market makers (AMM) algorithm.
In return, the liquidity providers are rewarded with LP tokens—for example, SLP tokens from Sushi liquidity providers. They are used to These tokens can be used to retrieve the deposit at any time plus any interest accrued from trading fees.
These LP tokens are important because DeFi apps that run liquidity mining programs require users to lock in their liquidity in order to earn governance token rewards.
Stake farms: In a stake farm, users deposit crypto into a smart contract that programmable facilitates a staking pool. A staking pool is like a decentralized vault for a single kind of asset. It doesn't facilitate trades but rather secures deposits.
Stake farms offer a much easier experience than LP farms, as users only have to deposit one asset in order to earn passive income. For example, Alchemix launched with a staking pool for its governance token ALCX. Users supply ALCX to the pool to earn more ALCX in return. This system incentivizes users to support the price of ALCX by holding it, and it helps Alchemix distribute its native token to its community of users.
Risks of Yield Farming
Yield farming is a relatively new phenomenon, and as such, it comes with several risks.
The first risk is rug pulls. A rug pull is when a yield farming protocol suddenly shuts down, and users lose their deposited cryptocurrency. This can happen for many various reasons, such as the team behind the protocol deciding to exit the scam. Rug pulls are a significant risk in yield farming and have led to the loss of millions of dollars worth of cryptocurrency. For example, in November 2020, the team behind the Harvest Finance protocol rug pulled $24 million worth of cryptocurrency from their users.
Another risk is fraud. The project protocol can have vulnerabilities that can be used by fraudsters to step LPs funds. For example, in August 2020, a vulnerability in the Compound protocol was exploited by a hacker who stole $350,000 worth of cryptocurrency.
There have been many instances of yield farming protocols promising high returns but then failing to deliver on their promises. This can often be due to the protocol being a Ponzi scheme or simply because the team behind it was not able to meet its targets.
Another risk is that of impermanent loss. This is when the price of the cryptocurrency in a liquidity pool falls relative to the price of the other assets in the pool. This can lead to users losing money even if the cost of the cryptocurrency they hold remains stable.
Lastly, yield farming can be a very complex and technical process. This means that there is a learning curve for users, and mistakes can be costly.
What is APY/APR in DeFi?
APY/ APR is the annual percentage yield/rate that a user earns on their investment in a DeFi protocol. It's calculated by taking the total interest earned over a year and dividing it by the principal investment. For example, if a user invested $100 in a DeFi protocol and made $20 in interest for a year, their APR would be 20%.
APR is not stable and can fluctuate greatly depending on the market conditions. This is because the interest earned on DeFi investments is directly linked to the price of the cryptocurrency. When the price of a digital asset goes up, the interest earned on DeFi investments also goes up. Similarly, when the price of a cryptocurrency goes down, the interest earned on DeFi investments also goes down.
There are a few websites that track DeFi APR, such as defipulse.com, defirate.com, and liquidityfolio.com. These websites allow users to see the current APRs for different protocols and compare them.
Total Value Locked (TVL)
TVL is the total value of cryptocurrency locked up in a DeFi protocol. It is a good metric to use when comparing the size of different DeFi protocols. The higher the TVL, the more popular and successful the protocol is. For example, as of November 2020, MakerDAO had a TVL of $800 million while Compound had a TVL of $350 million.
Yield Farming Platforms
There are many different yield farming platforms available. Some of the most popular are Aave, Curve Finance, Uniswap, and PancakeSwap.
Aave is a non-custodial decentralized lending platform on the Ethereum blockchain that allows users to earn interest on their deposited cryptocurrency. Aave is now in the top 5 DeFi protocols, accounting for around 11.5% by 2021 of the total value recorded in DeFi. Aave offers several advantages, such as depositing multiple types of cryptocurrency, variable interest rates, and no KYC requirements. Aave's entry into the DeFi ecosystem has boosted lending and borrowing, making DeFi money markets more complex for newcomers but offering more features for those with more experience in DeFi.
Curve Finance is a decentralized exchange based on Ethereum, specifically designed to exchange stablecoins. It allows users to trade cryptocurrency without depositing it into the platform. It also allows users to trade between different pools, which can lead to higher returns. In May 2020, Curve Finance launched its own CRV token.
Curve Finance offers a number of advantages, such as low fees, high liquidity, and no KYC requirements. The exchange offers the most income to those willing to contribute their stablecoins to its liquidity.
The popularity of the Uniswap decentralized exchange is constantly growing. This platform ranks first in the Ethereum (ETH) network regarding resource costs on commissions. You can buy, sell or exchange any ERC-20 standard tokens issued on the Ethereum blockchain.
The main advantage of Uniswap is that the users themselves control transactions. User funds are not kept on the exchange and are not controlled by site administrators. Another advantage is that the platform does not require registration, so the user's anonymity is preserved.
It is a platform based on Binance Smart Chain (BSC) for exchange and yield farming using BEP-20 tokens. PancakeSwap has its own CAKE token and is similar to Uniswap and SushiSwap. But unlike these Ethereum exchanges, PancakeSwap has faster transactions and lower fees because BSC is a much more centralized counterpart to Ethereum.
This platform is one of the largest in terms of the trading volume. The daily trading volume on the exchange reached half a million dollars. It is convenient to work with PancakeSwap due to the minimum required steps, and there are no mandatory registration and account verification.
Is Yield Farming Profitable?
Yield farming can be a very profitable activity if done correctly. However, earnings depend on the conditions and capabilities of a particular protocol, as well as on a strategy you choose and how accurately you follow it. Before you start working with DeFi, you should study in detail the nuances of decentralized liquidity protocols. Nevertheless, it is important to remember that it is a risky activity, and losses can occur. It is, therefore, essential to do your own research and keep your investment on the pulse.
How to make money with yield farming?
If you want to make money with yield farming, there are a few things you need to know.
- Сhoose the right yield farming platform. There are many platforms available, so you should do your own research and choose one that fits your needs. The platform you select must not have been hacked before and must have a high-security level.
- Deposit your cryptocurrency into a liquidity pool. You need to choose an asset carefully. For example, if a user wants to add funds to the liquidity pool on DEX, some token pairs may have higher APRs but, in the long run, have the risk of depreciating heavily.
You also should consider the market trend. In a bearish market, it is better to look at pairs with stablecoins, on a growing one, you can win at the expense of coins with potentially good growth.
Finally, you need to monitor the cryptocurrency's price in the pool and sell when the price is right.
Yield farming is a great way to make money with cryptocurrency. Nevertheless, it is important to remember that it is a risky activity, and you can lose money if you are not careful. It is, therefore, crucial to consider all the risks and do your own research before you start yield farming. With that said, yield farming can be a very profitable activity if you are willing to take the risk.