Yield farming is one of the hottest topics in decentralized finance, and there is a high chance you may have already heard something about the insane returns that some of the yield farmers are making through yield farming.
Yield farming is a new way to earn cryptocurrency that is better than holding, trading, or buying NFTs.
If you are lending your assets on Defi, you can make a lot more money than what you’d get from a bank. In fact, the interest rates on popular cryptocurrencies like Ethereum, Basic Attention Token, and Stablecoin are currently around 9–50%. To put this in perspective, most high-yield savings accounts only give you 1.9% interest.
To find out more, keep reading. We’ll explain how yield farming works and some of the key points you need to know before diving in yourself.
What is “yield farming”?
Yield farming is also called liquidity mining. The term “yield farming” contains two words: “yield” and “farming.”. The term “yield” is a financial term that means what you give for investing and farming and represents the possible expansion growth you can receive.
Simply put, yield farming means’ locking cryptocurrency and taking rewards on a decentralized ecosystem. But it’s hard to define yield farming because it looks like staking and liquidity pools.
The key idea behind yield farming is that smart contracts are used as ‘liquidity pools.” These liquidity pools can accept deposits from users, which are then lent out to other users in exchange for fees.
How does yield farming work?
Most yield farming happens on decentralized exchanges (DEX), and DEX follows smart contracts or automated market makers to execute the funds from the liquidity pool.
A liquidity pool is a marketplace where users can exchange, lend, and borrow tokens. And the fund of the pool is fulfilled by liquidity providers.
To earn reward liquidity, providers have to deposit funds into a pool in two different tokens in a 50/50 ratio, most of which are ETH, BNB, or Stablecoins.
The usage of this pool incurs fees, which are then paid out to liquidity providers according to their share of the liquidity pool. This is the foundation of how a smart contract works.
How much can you earn through yield farming?
There are several methods you can use to earn money through yield farming, but in all of them, assets and the number of transactions are common. These are the most popular methods for high-yield farming.
Liquidity providers are an important part of the decentralized financial markets. They provide a necessary service by supplying liquidity to the markets. This liquidity is used by investors to make trades and by traders to enter and exit positions from the liquidity pool.
Let’s say you provide $1000 ETH and $1000 BAT (total $2000) liquidity into a pool, which is 1% of the pool value. The next day, tons of trade happened between ETH and BAT, with a total value of $2 million. If the fee was 0.5%, then a total of $10,000 was collected during that trade. Because your position was 1%, you will get $100 in one day based on your $2000. This money comes from users who happily pay the trading fees using the fund you provide to swap the token.
How much you will earn from yield farming depends on how much liquidity you provide in the pool. Trading fees and trading value will affect earnings. So do proper research before investing. For liquidity providers, Defi working on Ethereum like UniSwap is heaven because they have a higher fee percentage.
“Crypto lending” is a term used to refer to lending cryptocurrencies for interest. This way, you can get more crypto in return by lending your assets to borrowers for a certain time.
This type of activity is very common in the financial markets, but it’s also available on a smaller scale to users who want to lend their cryptocurrencies and get more in return.
The main difference between lending crypto and fiat is the fact that the latter is backed by governments, while the first one is backed by a smart contract.
For example, you can lend Ethereum and earn interest. You can also do this with stablecoins such as Tether (USDT), Binance Coin (BNB), and True USD (TUSD) and earn interest from them.
Crypto lending is considered one-off, easy, and secure for yield farming because it is also available on centralized exchanges, which are recognized by the government.
There are many platforms that offer higher returns than banks. Some centralized platforms, like Binance, Coinbase, Crypto.com, and Gate, and some decentralized platforms, like UniSwap and PancackSwap, offer crypto lending services.
Proof-of-stake (PoS) is an alternative to the proof-of-work (PoW) system, and this trait attracts lots of users involved in yield farming. Do not get confused between crypto staking and crypto lending. Both are different, with some common. Crypto staking means leasing your crypto to the blockchain, while crypto lending means leasing your crypto to the borrower for a specific time on the platforms. In return, you get rewarded with new coins or tokens. You can also collect transaction fees paid by other users on the network.
Staking works similarly to mining, but it doesn’t require expensive hardware and software solutions. The staking process involves locking your crypto assets into a specific wallet or protocol that validates transactions on the blockchain and secures the network. The more cryptos you stake in this process, the more rewards you get.
What are the best yield farming platforms?
Like I said, there are two types of platforms: centralized and decentralized for yield farming. You can choose any of them, but decentralization gives much more return than others.
If you are just starting yield farming, then lending or staking could be great on centralized platforms, but if you know how things work, then you can try the liquidity provider method on decentralized platforms. Make sure you use the Ethereum network to get more returns.
An Ethereum-based open marketplace that allows its users to borrow and lend crypto assets. Anyone with an Ethereum wallet can participate in a pool and earn rewards, which are adjusted algorithmically based on supply and demand.
The compound has 18 markets, and rewards are distributed in compound tokens. For supply, it gives a 0.05% to 8.46% reward, while borrowing interest is 0.34% to 19.53%.
Nexo is a centralized platform for crypto lending and borrowing. It has almost every feature that a beginner needs to start yield farming. With Nexo, you can put your idle assets to work right away and have a predictable source of passive income without the risk. It supports 32 cryptos, including BTC and ETH, with a 6% to 34% interest rate. The rate will increase by 2% if you claim your reward in NEXO coins.
A decentralized platform for lending and borrowing, which is heavily used for yield farming. The reward varies from coin to coin and is paid in Aave tokens. The deposit rate ranges between 0.01 and 12.77%, and borrowing is below 35.61%.
A leading decentralized exchange platform that supports ERC20 tokens. UniSwap has two versions, V2 and V3, that are heaven for yield farming via liquidity providers. To participate in the pool, users have to provide a 50-50 ratio in a certain cryptocurrency to earn rewards, which are paid in UNI tokens. The V3 version has 672 markets, while the V2 version has 1758 markets.
This one is following the same path as UniSwap, but it works on the Binance Smart Chain network (BSC) to support BEP20 tokens. Pancake offers many features, like gamification with the lottery, team battles, and NFT collectibles, which make it more attractive for yield farming.
It is a fork of UniSwap. On it, you can swap, earn, stack yields, lend, borrow, and leverage all on one decentralized, community-driven platform. Its native token is SUSHI.
What are the good things about yield farming?
- Yield farming is all about earning as much profit as possible.
- The profits are earned by providing liquidity to decentralized exchanges and staking tokens in different protocols.
- By providing liquidity, you receive a share of the transaction fees.
- The earlier you come, the more you will earn.
- By staking, you’re able to earn the protocol’s native token, which can be traded for other digital currencies on cryptocurrency exchanges.
- In addition, high-yield farmers often have to take out loans, which are secured with their digital assets as collateral.
- It offers higher returns than these traditional methods thanks to its ability to compound earnings over time through compounding interest rates—meaning that if you reinvest your earnings into the same investment, you’ll get even more returns!
What are the risks of yield farming?
- Yield farming can be quite risky because it involves moving cryptos from one platform to another, and many of these platforms have been hacked before. This means that there’s always a risk of losing your cryptos if you’re not careful with who you choose.
- One of the most important things you need to understand about yield farming is that the most profitable strategies are highly complex. They may also require you to hold large amounts of capital in order to take advantage of them, so if you are new to crypto or don’t have much liquidity available, then yield farming may not be right for you.
- Also, yield farming isn’t something that can be done easily and without risk. If you don’t understand what you’re doing or aren’t careful with your investments, then you might lose money.
- One obvious risk of yield farming is smart contracts. If there’s a bug in the code, your funds can be stolen or sent to the wrong address.
- The failure of Defi products is also a great threat to yield farming. We have witnessed Maker DAO’s failure in 2020.
- Any type of cryptocurrency can be used for yield farming, but not all cryptocurrencies.
- A Defi product can be accessed only with a non-custodial wallet, so if you lose your wallet, you can never access your funds from Defi.
- Getting constant returns is hard because other users throw high volumes of money at holding a higher position.
- Every Defi protocol gives a reward in their native token, and many investors think it could be risky because the circulation supply of tokens is increasing day by day, and eventually the price can go to zero.
Yield farming is generally more suited to those that have a lot of capital to deploy (i.e., whales). If you don’t understand what you’re doing or don’t have enough money on hand to buy into a protocol and get liquidity going, you’ll likely lose money. Choosing the right pair also determines how much you will earn.
The more popular pair you choose, the more money you need to hold the position. So make your own wise decisions and do your own research before putting money into yield farming.