Yield Farming: A complete guide

Yield farming is a method of generating more cryptocurrency with your existing cryptocurrency. It entails you lending your money to others using the magic of computer programs known as smart contracts.

What is Yield Farming?

When you put money in a bank account, you’re effectively making out a loan for which you’ll be paid interest. Yield farming, also known as yield or liquidity harvesting, is the practice of lending cryptocurrencies to other people. You get interest and fees in exchange, but they’re minor compared to the practice of supplementing interest with free units of a new cryptocurrency. Real money is made if the coin appreciates quickly.

How does it work?

Yield agriculture is closely related to a model called Automated Market Maker (AMM). They are usually liquidity providers (LPs) and liquidity pools. Let’s see how it works. The liquidity provider places the funds in the liquidity pool. This pool operates a marketplace where users can lend, borrow and exchange tokens.

There is a fee to use these platforms and they are paid to the liquidity provider according to their share of the liquidity pool. This is the basis of how AMM works. However, the implementation can be very different. It goes without saying that this is a new technology. There is no doubt that we will see new approaches to improving the current implementation.

In addition to fees, another motivation to add funds to the liquidity pool could be the distribution of fresh tokens. For example, there may be no way to buy small quantities of tokens on the open market. On the other hand, it can be accumulated by providing liquidity to a particular pool. All distribution rules depend on the unique implementation of the protocol. The bottom line is that liquidity providers earn profit based on the amount of liquidity available in the pool.

Deposited funds are usually stablecoins fixed in US dollars, but this is not a general requirement. The most common stablecoins used in DeFi include DAI, USDT, USDC, and BUSD. Some protocols create tokens that represent coins stored on the system. For example, if you deposit DAI in Compound, you will receive cDAI or Compound DAI. When you deposit ETH to Compound, you will receive cETH.

Which Yield Farming Method Should You Use?

Keep in mind that there are a variety of YF techniques available, and new ones emerge on a regular basis. It’s impossible to use all of them at the same time. It can also be difficult to remember them all by heart. To put things right, research each platform you want to use to see which strategies it recommends. Furthermore, having a general understanding of how decentralized liquidity protocols function should suffice for the first time. Any expert will warn you that you should avoid mindlessly depositing money on the first website you come across. Also, be aware of the risk management guidelines. To make things easier for you, we’ve compiled a list of popular YF protocols. You can find them listed below.

  • Compound finance – Tokens can be borrowed or landed here. To begin, you must create an Ethereum wallet. Only with it at your side will you be able to begin winning prizes that will compound over time. Compound Finance automatically adjusts rates based on supply and demand. This method is one of the most popular.
  • MakerDAO – The DAI stablecoin is supported and maintained by the decentralized credit service. Maker Vaults can be created by anyone who prefers this platform. Stablecoin can be generated as a debit against locked collateral assets like ETH, BAT, WBTC, and USDC. This platform assists in the selection of high-yield farming systems.
  • Synthetix – It’s an intriguing blockchain-based distributed asset issuance system based on the Ethereum network. This protocol stands out from the rest due to a few unique features. Synths can be created and converted by anyone. Peer-to-contract (P2C) trading means that all transactions are completed quickly and without the use of an order book. Any Synth can be traded for another Synth, and this platform provides near-infinite liquidity. A group of coin owners is responsible for providing collateral and ensuring the service’s stability.
  • Uniswap – Precarious currency trades are possible on this platform. To build a market, liquidity pool participants need to invest the equivalent of a couple of coins. They get their fees from pool trades in this way. Many traders are drawn to Uniswap because of its frictionless nature. When experimenting with various YF methods, keep this platform in mind.
  • Balancer – What distinguishes this protocol from others? Instead of the 50/50 allocation claimed by some rivals, it enables the creation of unique Balancer pools. Custom coins can be assigned to a liquidity pool by providers. The trades that take place in liquidity pools then profit liquidity providers. Balancer has a lot of versatility, and it’s a fun approach to look at YF strategy.

The risk of Yield Farming!

The digital money you lend out is effectively kept by software, and hackers always appear to be able to find new ways to attack code flaws and steal money. Some of the coins users are depositing for yield farming are only a few years old at most, and they could lose value, leading the system to crash. Furthermore, early investors frequently own substantial amounts of reward tokens, and their decisions to sell could have a significant impact on token pricing. Finally, regulators have yet to decide whether incentive tokens are or may become securities, which could have a significant impact on their use and value.

Many high-yield harvesting methods are likewise vulnerable to liquidation. Many users are implementing complicated tactics in order to optimize returns. The goal is to earn a larger share of the available rewards: Comp tokens. A change in the value of a token in the wrong direction might wipe out any gains and force liquidations.

furthermore, During the peak of the decentralized financing season, gas fees increased by about 100 times. If they continue to rise, YF may become unaffordable for most traders. ETH has launched Ethereum 2.0, which includes layer II scalability to address the issue of excessive gas fees. Reduced gas fees are also available from BNB, NEO, and TRON. Developers have control over your currency, so there is a risk that they will run away with it. The risks are much higher if you do not know the developers. Participants should always ensure that the pool they have chosen has been thoroughly examined by a team they trust, but this does not completely eliminate all threats.

Closing thought

Yield farming is going through some growth pains right now. The current level of yield farming has been compared by some experts to the early days of the internet. However, many of the difficulties that yield farmers face are just transitory. Yield farming will most certainly become a more smoother operation in the future, with clearer expectations for investors.