The launch of the DeFi sector has brought a lot of hype around its new products and features. One such feature that has become commonplace in the industry is DeFi yield farming. This unique protocol allows new users to earn passive income without understanding market conditions and cryptocurrencies in general. For these reasons, DeFi yield farming is one of the fastest growing crypto investment sectors out there.
DeFi yield farming or staking allows individuals to earn tokens in exchange for their participation in DeFi applications. Currently, users can stake stablecoins like Dai, USDT or USD Coin along with endless platform governance tokens. It is also possible to yield farms using cryptocurrencies like Ether since most of the platforms are currently on the Ethereum blockchain.
What problems is DeFi yield farming trying to fix?
DeFi yield farming is attempting to fix some major issues currently plaguing the market. First and foremost, yield farming offers new crypto users an easier alternative to generate passive income. Compared to cryptocurrency trading, yield farming requires less understanding and effort. In this way, yield farming offers a safer alternative to trading cryptocurrencies with no experience.
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How does DeFi yield farming work?
Each platform has its own technical specifics related to its yield farming strategy. Therefore, you need to invest a little time to better understand the advantages of each platform such as blocking periods and response rates. In general, however, the most common yield farming method requires you to lock your cryptocurrency into a liquidity pool smart contract.
Depending on the platform, the liquidity pool can serve multiple purposes. Your liquidity could be locked in a public pool that allows users to borrow the funds with interest. This interest also goes back into the fund for more rewards. In the end, this strategy creates a profitable loop for savvy investors.
There are also liquidity pools that fund projects in the market. In this scenario, you receive rewards for helping to boost the liquidity of a specific project. This is currently the most common type of yield farming. It was also the original strategy envisioned by developers in space.
Advantages of DeFi yield farming
DeFi yield farming has many advantages. For one, this approach gives investors access to greater ROIs with less effort. Early bird investors benefit the most as they earn rewards and benefit from the token’s appreciation during launch. Typically, investors take those profits and reinvest them in other DeFi projects for even more returns.
interoperability
The entire DeFi sector is built on interoperability, which makes the market extremely versatile. Some platforms take your staked crypto and automatically pass it from platform to platform. All of this interoperability improves returns for investors and gives users more options. It is common for experienced investors to stack logs to keep increasing profits.
History of DeFi yield farming
The history of yield farming begins in the summer of 2020. That was when COMPOUND launched the service for the first time. COMPOUND’s strategy was to offer users a small portion of transaction fees if they contribute liquidity to a specific application. In this case, COMPOUND started with pools on Uniswap or Balancer. Both services proved extremely successful.
DeFi liquidity locked via Coindesk
This success led to a spate of copycat platforms entering the market. In addition, some high-end platforms also entered the space, expanding the yield farming concept. These platforms introduced features like associated governance or native tokens. Platforms also started rewarding users with native tokens instead of ETH.
Advanced yield farming
Advanced yield farming tactics have emerged due to the interoperability of the sector and the rapid adoption of new and exciting farming methods. These users stake tokens in a chain of protocols for maximum yield. These advanced staking methods generate unmatched ROIs but are very complex for the average user.
Risks of DeFi yield farming
Yield farming is exciting, but comes with a variety of risks to consider before investing. If you want to earn a great reward for your farming efforts, you must first and foremost raise a high value of initial capital. This increases your risk exposure.
Pure speculation
Additionally, the high volatility of DeFi tokens is a cause for concern. Most DeFi investors are currently purely speculative. They intend to resell their token for a profit at a later date. The problem with this group of investors is that they often show shaky hands.
Speculative investors sell their holdings quickly during market downturns. These sales can lead to a cascade of other investors to follow. It ends up in a run-off sale that wipes out the value of the platform and leaves investors suffering.
A perfect example of this is when Hot Dog Swap posted big losses this year. In the incident, the market suddenly collapsed, leaving investors bag in hand. Hotdog, in particular, lost 99.9% of its value in just a few hours after launch.
Coding Risks
Coding risks are another issue investors should consider. Many of these platforms are not open source. This means that the coding has not been verified by the community. When a project’s team and underlying smart contract codes cannot be verified, the risk increases significantly. The DeFi sector is booming and developers are constantly booting projects from scratch or copying the code of their predecessors. Leaks occur whenever the code is unchecked, since bugs and attack vectors are more likely to be discovered by users and hackers than by developers.
A perfect example of how flawed coding can cost investors happened at YAM Finance. A line of bad coding wreaked havoc on this startup. Notably, the platform saw its utility token soar to $57 million in value in just two days due to coding errors. This growth was an obvious coding error. Subsequent investigations revealed a plethora of coding and security concerns with the platform.
DeFi Yield Farming – What the future holds
The DeFi sector appears to be on track to solidify its position in the market. However, similar to the ICO boom of 2017, investors need to DYOR before venturing into this market. When done right, DeFi yield farming is a great way to earn free crypto. However, your success depends directly on your ability to accurately assess a platform’s validity.
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