The previous lesson covered the inner workings of liquidity mining, a popular way of leveraging existing crypto assets to earn more crypto by providing liquidity to decentralized exchanges. In addition to liquidity mining, DeFi also offers another yield product: yield farming.
Yield farming came along with governance models in the summer of 2020. As more and more developers focused on expanding DEXs and improving their level of decentralization by delegating the decision-making process to the community, a unique Yield product emerged. Yield farming is essentially the same as liquidity mining, with the main difference being that farmers also earn LP or governance tokens.
What is yield farming?
Each decentralized DeFi project has a unique governance model. The utility of this model comes from the use of governance tokens. A person who provides liquidity to a DEX with a governance model not only earns fees but also governance tokens.
Alternatively, the protocol grants LP tokens – a token representing a user’s share of the liquidity pool. LP tokens are ERC-20 tokens and are held in the contributor’s wallet, meaning they can be actively used for other DeFi protocols. The bottom line is that you can maximize your profits by farming existing crypto assets and farming new LP tokens as well.
Another important point to keep in mind is that yield farmers are aggressive in the crypto market. In order to earn the best rewards and stay competitive, they are forced to constantly hunt down liquidity pools with the highest APY rate.
This passionate activity led to the creation of yield farming aggregators, protocols that allow farmers to participate in the best LPs from one place. A notable example of a yield farming aggregator is Yearn Finance, the popular DEX created by famed DeFi developer Andre Cronje.
Similar to liquidity mining, yield farmers also suffer temporary losses – with the difference that the risk is far higher if farmers decide to also farm LP tokens.
A step-by-step guide to yield farming
A simpler way to understand yield farming and its increasing complexity is with a step-by-step guide. We used MetaMask as an example, so be sure to read our guide on using MetaMask if you need help. Here are the eleven steps you need to take to farm:
- Buy BTC, ETH, USDT, USDC or DAI. These are the most widely used cryptocurrencies for generating income on most DeFi protocols. Note that no matter what you use as gas, you need to buy some ETH, which we will explain later.
- Download the MetaMask Wallet browser extension. After installation, create a wallet and securely back up your keys and seed phrase.
- MetaMask wallets contain ERC-20 tokens – tokens issued on the Ethereum blockchain. Coincidentally, most DeFi platforms are also based on Ethereum. So you should have no problem sending the currencies from step one to your MetaMask, with the exception of Bitcoin. If you want to use Bitcoin on the Ethereum blockchain and store it in your MetaMask, you must first wrap it with the Ren Bridge to create wBTC, or buy wBTC on an exchange.
- Once your ERC-20 tokens are safely in your MetaMask wallet, you can start interacting with DeFi platforms and begin the never-ending fun of yield farming.
- For simplicity, we recommend learning Yield Farming with Compound Finance. Compound started the yield farming craze and is in many ways the most beginner-friendly DeFi platform. Go to Compound and then click the app button in the top right corner.
- After clicking App, you will be prompted to connect your wallet. Click on the MetaMask option and then login to your MetaMask.
- On the landing page of the landing page, select the asset you want to serve. Select the amount you would like to pledge, then click Deliver. Note that two APY numbers are displayed: Supply APY and Distribution APY. The former is paid in kind (like the deposited asset), the latter is paid in the form of COMP. This means that you earn two types of APY for one deposit.
- MetaMask will ask you to confirm two transactions. The first is to interact with the compound smart contract, the second is to confirm the transaction. Both cost gas, which is paid for in ETH, which is why we advised in step one to keep ETH in your wallet regardless of your chosen supply asset.
- After the transactions are confirmed, the Compound app will notify you that everything is ok and your balance column will be populated with the amount you specified. To the left of the balance is the “APY/Earned” column, which shows both your APY rate and how much you’ve earned.
- At the top of the Compound page is a Net APY gauge to help you keep track of your total APY earned between the bid APY and sales APY rates.
- To increase the potential of your yield farm, you can now borrow against your provided assets to earn even more APY (paid in COMP) while selling those assets to Compound or any other platform DeFi platform like Aave, Yearn Finance or Borrow Curve Finance.
Diploma
Yield farming is practically the same as liquidity mining. However, there are some key differences that could be a key obstacle when deciding between the two. Summarize:
- Yield farming is competitive.
- Yield farming offers better rewards.
- Yield farming protocols distribute LP tokens, or governance tokens, in addition to fee rewards.
- When LP tokens are farmed, IL risk rates increase.
Due to their difficulty, we recommend the following yield farming protocols.
Simple mode:
- joint financing
- Manufacturer DAO
- Spirit
intermediate:
- Uniswap
- SushiSwap
- synthesis
- curve financing
- year finances
- Badger DAO
- cream finances
- crop financing
- equalizer
Expert mode:
- Alpha Homora
- mirror log
- metastable
- loop ring
- dYdX
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