Sowing Success: The Power of Yield Farming on Crypto Networks
TL;DR:
The latest part of our beginner’s guide to DeFi focuses on yield farming, where crypto assets are delegated to earn interest. The first part of the guide explains how networks use yield farming to attract users and create value. It introduces the cold start problem and explains the terms “Annual Percentage Yield” (APY) and “Annual Percentage Rate” (APR) and their relevance for yield farming.
Welcome to the latest installment of our beginner’s guide to DeFi. This three-part blog post focuses specifically on yield farming. In the first part, we examine the importance and purpose of yield farming before delving into the specific strategies and associated risks. Finally, we present three popular tools that can help you get started with your own yield farm. Let’s dive in!
Yield farming is the passive delegation of crypto assets to a network with the intention of attracting interest. The term “passive” refers to the fact that you deploy your position without requiring constant guidance from you. The interest rate will change over time but is predictable and can be adjusted depending on your goals as an investor. All of these strategies come with risks. Therefore, please do not take this guide as investment advice and always do your own research.
Sowing the Network: Why Networks Offer Yield Farming
Yield farming allows projects to reward farmers for helping generate the core value of their supply. At the beginning of a network it is extremely difficult to generate values. This is commonly known as the cold start problemand it affects many networks, not just blockchain networks.
For example, if you’re the only person in the world who owns a phone, it’s basically worthless. You cannot call anyone because there is no one else on your network. But as more people join the network, it becomes increasingly, and almost exponentially, more valuable.
That’s why companies like Facebook and Uber are so successful. They are able to generate tremendous value because they can create “walled gardens” in which people are trapped and cannot share their data with competing networks. And for this reason, many cryptocurrency projects offer yield farming: they try to seed their networks to reach a point where their network reaches critical mass and can grow more organically.
Perhaps we can better illustrate the cold start problem by providing examples of two traditional companies and their solution to building their network. First, consider that Uber might offer a $1,000 bonus to a new driver who completes 50 trips in the first 30 days. Uber has very localized networks so every time they enter a new city they have to set up the new network. That’s a huge task! By offering incentives to new drivers, they effectively strengthen their network.
As another example, Venmo offers to deposit $10 into your app account before you even start using the platform. In this case, they offer an incentive for one of two actions: 1) They wire the $10 to their bank, which means you need to add their bank details to your app, and once all the details are entered, you’re more likely to do so, that you continue to use the app; or 2) you send the $10 to someone else. This third party is either an existing Venmo user or a new user who must also choose one of the paths mentioned to further strengthen the network.
A cryptocurrency protocol also needs to seed its network in order for it to take root. A popular way to achieve this is to incentivize users in the form of yield farming. The network gets new users and activities to support it, while farmers receive returns on their assets and other incentives. Rewards are generally relatively high in the early stages of a network, encouraging early participation.
APY and APR
Finally, before we move on to the different methods of yield farming in the next part of this article, let us define two important terms that are relevant to yield farming:
Annual Percentage Return (APY): This number is useful for those who lend assets as an investment. APR is expressed as a percentage and represents the amount of money (interest) you would make if you held your investment for one year. Note that this figure assumes you reinvest the interest you earn compounding.
Annual percentage (APR): This number is commonly used by borrowers. The APR is also expressed as a percentage and represents the cost of a loan, including the interest rate, fees and (if applicable) insurance. If there are no fees or other costs associated with a loan, the APR should be the same as the interest rate. The APR can be fixed or variable depending on the product.
In summary, yield farming is a practice that allows investors to passively earn interest on their crypto assets by delegating them to networks. It helps networks add value and incentivizes early participation. For a deeper understanding of yield farming methods, join us in the next part of this guide.
Beginner’s Guide to Crop Farming
Part 1: Seed Success: The Power of Yield Farming on Crypto Networks
Part 2: The five most important methods of yield farming
Part 3: Research and Analysis Tools
Also in this series
crypto wallets
DEX vs CEX
DeFi lending and borrowing
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