Yield farming pertains to various yield-generating approaches an investor can pursue in DeFi. These approaches are employed to provide investors with ways of earning passive income on their crypto assets.
These approaches manifest as staking, pooling, or lending one’s assets – this is accomplished by locking them in smart contracts in decentralized applications or dApps. In exchange for locking one’s assets, the “farmer” earns a yield, which is gauged in terms of APY – this yield comes in the form of additional tokens.
Yield Farming Protocols
Since the summer of 2020, the array of yield farming options has expanded significantly, and some yield farmers utilize multiple protocols to maximize and diversify their gains. Well-liked yield farming protocols comprise AAVE, Curve, Uniswap, THORChain, and Yearn.Finance. It’s worth mentioning that each protocol has its own subtleties for earning yield. For instance, depending on the contract, the farmer may be able to promptly withdraw the funds or must keep it locked for a predetermined number of days. Additionally, some projects are more reputable and secure than others, so ensure to research which platform, risk level, and yield farming strategy appeals most to you.
Yield Farming Techniques
Staking, employed in Proof of Stake networks, aids in securing the blockchain on which the crypto is being locked. For aiding in securing the network, a staker receives a yield on their deposit.
Liquidity providing is when an investor enters a smart contract to furnish liquidity to a protocol and the protocol utilizes their crypto for swaps; this assists in maintaining market liquidity. The pooler receives fees from the trader’s each transaction.
Lending locks one’s assets in a smart contract that will be utilized to lend your assets out to other users. The protocol offers yield incentives In return for making your assets available to lend out to other users.
What are the major risks of DeFi Yield Farming?
As mentioned earlier, some protocols are more secure than others and yield farming does entail inherent risks. Here are some of the most prevalent risks related to Yield Farming:
When lending, staking, or pooling, a yield farmer’s assets are no longer in a user’s wallet but rather in a pool or in a smart contract. Sometimes, hackers are able to find some sort of exploit and pilfer funds from that smart contract. Therefore, one should not yield more than they are willing to lose.
The degree to which the price of an investment fluctuates in either direction is called volatility. A volatile asset can have a significant price fluctuation in a short period of time. Yield farmers take a significant risk when locking up tokens due to the potential for price fluctuations, especially during bear markets.
Concerning liquidity pools, a rug pull is a scenario where a seemingly too-good-to-be-true new token will offer outrageously high APY. The more yield farmers deposit funds into a liquidity pool, the rug puller, who is holding a significant share of the pool value ahead of time, will withdraw their share of funds and dump the tokens, essentially ruining the market for that token. Beginners need to make sure to do their research on any protocol before yield farming on their dApp and should keep attention on how the liquidity in the pool was initiated, as well as how much has been “locked” by the founders.
Some tokens/ dApps are actually scams that offer massive APY or promised utility to entice investors and farmers and then proceed to pilfer the funds. Again, it is imperative to put in the time and effort to comprehend which yield farming opportunities fully are genuine and which are not.
Regulation of the dangers of cryptocurrencies on a global scale is still unclear. The Securities and Exchange Commission ( SEC ) currently regulates some digital assets because it has determined that they are securities. Government officials have already filed cease and desist orders against centralized cryptocurrency lending platforms such as BlockFi, Celsius, and others. If the SEC classifies DeFi loans and borrowings as securities, the number of ecosystems offering lending and borrowing could be significantly reduced.
At the End
Yield farming offers different investment methods. However, the growing interest in crypto assets is undoubtedly creating many new investment opportunities. On the other hand, investors must understand the approaches they are using to achieve returns. In fact, the higher reward potential is in Yield Farming, especially on DeFi, the less likely it is that the project will be available in the long term. However, beginners need to double check about the factors that matter most, such as safety or passivity, and build your strategy around them.