Many applications in decentralized finance (DeFi) offer passive income or “yield” in return for deposit cryptocurrencies into their protocols, and people strategizing to move crypto across DeFi protocols to maximize their returns are called “yield farmers.” DeFi yields fluctuate all the time, so it makes sense to “rotate” deposits between protocols to get the highest yields. This requires sophisticated strategies and advanced knowledge of DeFi to operate that are jealously guarded to maintain profitability.
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One of the biggest innovations in DeFi was the Lending and Borrowing app, which allows users to deposit crypto into a pool and either lend it out to other users against interest payments or lock it up as collateral to take out a loan in a different cryptocurrency. DeFi protocols are all interoperable via smart blockchain contracts, allowing developers to chain multiple actions across multiple DeFi apps to build new financial services. Also, newly launched protocols offer high rewards for people willing to take the risk of depositing their crypto in exchange for the high rewards, but there is also a very high risk of the protocol going bankrupt, collapsing, or turning out to be a crypto Carpet train exposes fraud.
Binance Academy explains that due to DeFi protocols with variable APY rewards, yield farming is very complex, and maximizing yields often involves “rotating crops” across the highest-paying protocols. Yield farming strategies are sophisticated and very closely monitored because yield farming strategies become less profitable as more people use the same strategy. Yield farming typically relies on “pools of liquidity,” which are large pools of cryptocurrency used to facilitate financial services, and this is how Decentralized Exchanges (DEXes) work. Liquidity pools must provide rewards to their Liquidity Providers (LPs), which is where the yield farming rewards come from.
Yield farming is difficult and risky
Yield farming is not easy to get into, nor is it always safe to cultivate. Higher APYs almost always come with a higher risk of loss. New DeFi protocols with flat liquidity pools are more vulnerable to high volatility and the possibility of a collapse. Yield farmers need to actively manage risk and reward while keeping an eye on which DeFi protocols offer higher yields in order to move their tokens to the pool with the next highest payout. Yield farmers who keep their cryptos in a high APY pool for too long risk the mistake of being ruined and losing some or all of their cryptos.
Yield farming is a well-known term in cryptocurrency, but it is also difficult to engage in and can result in losses if the yield farmer is not careful with their strategy. Yield farming is very sophisticated and usually requires knowledge of developing smart contracts and connecting multiple DeFi protocols to maximize returns. Yield farmers also have to rely on bots and blockchain oracles to know when it’s time to rotate their crypto crop, and employ risk management and hedging strategies to mitigate their cryptocurrency losses.
Sources: Binance Academy
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