There is no shortage of opportunities to earn incredible interest from crypto. But you have to be selective if you want to come out on top.
Cryptocurrencies offer numerous opportunities to potentially make money. The traditional option is to buy a cryptocurrency you like and hope the price goes up. However, that’s just the tip of the iceberg. Another method that is gaining in popularity is yield farming. You lend a cryptocurrency and earn interest on it.
The appeal of yield farming is that some projects offer extremely high interest rates. I’ve seen several with annual percentage returns (APY) in excess of 100%. APY is the annual interest earned on your deposit. You can even find projects that offer over 1,000%.
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As with anything that sounds too good to be true, there’s a catch. Primarily, interest is paid in cryptocurrencies, which means your earnings depend on the value of that cryptocurrency. However, it is possible to achieve a high yield through yield farming. Here’s exactly how it works and what to look out for.
This is how yield farming works
Yield farming is all about striving for the biggest returns with crypto lending. There are many websites that offer interest on crypto, but the highest interest rates are found at decentralized crypto exchanges (exchanges without a central authority). Here are some of the biggest decentralized exchanges right now (with names you only see in the crypto world):
- Uniswap
- sushi exchange
- burger swap
- PancakeSwap
All of these exchanges allow you to contribute to liquidity pools for different cryptocurrencies. A liquidity pool is a collection of cryptocurrencies that people pool to provide liquidity to the exchange. For example, if you lend your funds to an Ethereum liquidity pool, the exchange will receive more Ethereum to use for transactions.
Anyone who lends to a liquidity pool receives a share of the trading fees for that cryptocurrency. Lending to an Ethereum liquidity pool gives you a fee reduction when users trade Ethereum.
How much can you earn this way? That depends on the exchange and the liquidity pool you choose. PancakeSwap includes the APY for all of its pools. Lending the exchange-owned token (CAKE) can earn you over 130% APY at the time of writing. There are pools with significantly higher interest rates, but the cryptocurrencies involved are also more volatile.
The disadvantages of yield farming
Various risks and problems can arise in yield farming:
- The cryptocurrencies you lend could lose value. This is known as fleeting loss.
- Interest rates are falling as liquidity pools become more popular.
- Some liquidity pools turn out to be scams. Others end up being hacked and losing their crypto.
Given how volatile cryptocurrencies are, a temporary loss is always possible. The value of the cryptocurrency you lend could fall, possibly erasing your interest gains. An APR of 100% doesn’t mean much if you’re earning it with a cryptocurrency that’s price has fallen by 90%.
If your chosen liquidity pool performs well, expect the interest rate to fall. Pools of little value need to offer high interest rates to attract lenders. As more cryptocurrencies are added, interest rates drop accordingly.
Finally, there is the issue of security. Liquidity pools are a favorite playground for scammers. Many pools were created with the sole purpose of adopting and operating people’s cryptocurrencies. Hackers are also targeting exchanges and their liquidity pools. Last year, popular exchange Harvest Finance lost $24 million in a hack. You don’t have to worry about that if you’re growing your money in high-yield savings accounts, since they almost always come with FDIC insurance.
Should You Farm Crypto?
Income farming is a risky and rewarding endeavor. It’s also more complicated than simply buying and holding cryptocurrencies. If you’re willing to spend some time learning about it and trying out different pools of liquidity, it may be worth investing a small portion of your portfolio.
Because of the risk involved, I would recommend not investing more than 1% of your investment portfolio in yield farming. You might want to start even smaller when learning the basics.
If you are looking for a slightly less risky option, you can lend your cryptocurrency to a centralized exchange. The Gemini exchange is an example of a centralized exchange that offers the Gemini Earn crypto lending program. Interest rates are significantly lower, but it is a safer borrowing option. There is also the KuCoin exchange where some crypto owners earn 25% interest.
how to start
Here is the process to farm crypto for the first time:
- Choose an exchange and a liquidity pool.
- Get the cryptocurrency you need for your chosen pool. You can exchange other cryptocurrencies for it on the exchange’s website. You may also be able to buy it on one of the major cryptocurrency exchanges.
- Connect your wallet to the exchange. Each exchange has a button you can click to link your wallet and deposit crypto.
- Go to the desired pool and click the button to add liquidity.
- Decide how much crypto you want to deposit and approve the transaction.
The most important part is choosing an exchange and a liquidity pool. Find out about the reputation of the exchange and the cryptocurrency you want to lend. Even if you earn interest, you still want a cryptocurrency that has the potential to grow and not depreciate in value.
After you make your deposit, your crypto is added to the pool and begins earning interest. You can view your balance at the stock exchange at any time. Just go to the exchange’s website, connect your wallet and the pool will show your current balance.
If you want to withdraw your cryptocurrency, you can do it in the same way. The only difference is that instead of choosing to add liquidity, you choose the withdrawal option. Some pools require you to tie up your crypto for a period of time or charge a fee if you withdraw your crypto too quickly. However, this is not the case with every pool. Many allow you to opt out at any time with no penalty.
Yield farming takes time to become familiar with and involves some serious risks. Because of these risks, it is not advisable to use yield farming as a substitute for buying stocks or investing your savings. However, there is potential for significant returns, so it could be a good small addition to your crypto portfolio.
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