Yield farming is the use of cryptocurrencies to generate, earn, and collect crypto rewards.
In more popular terms, yield farming allows investors to earn crypto like earning interest on money in a bank savings account. This example highlights passive return, where an asset owner can deposit money into an interest-bearing account and allow the system to pay it out periodically.
However, the term yield farming implies a more active process. Although the term originally described the metaphorical process of “planting” crypto in a log to “grow” and then “harvest” the earned crypto, it also conveniently describes how many DeFi users mimic the behavior of real farmers by doing so they change their crops.
Yield farmers often move their assets from log to log or even from chain to chain to take advantage of the highest yields. These returns are measured in Annual Percentage Rate (APR) or Annual Percentage Yield (APY). The main difference between the two is that only APY includes compound interest in the win rate.
Where does the income come from?
This depends on what function a user’s deposited crypto fulfills. Most of the naturally generated revenue comes from transaction fees, block production, log fees, or interest paid by borrowers of digital assets.
However, many DeFi platforms initially boosted their yields with venture capital and supplemented organic ecosystem payouts to attract yield farmers and encourage adoption. This trend among DeFi platforms declined and decisively preceded the rise of CeFi institutions looking to replicate the high growth rates seen in the earlier days of DeFi.
How does yield farming work?
Yield farming consists of “farmers” using their funds in one of three main ways: Mark out, loanAnd Provision of Liquidity. By providing any of these services with their crypto, users get an opportunity to earn a portion of the fees, interest or rewards and collect new crypto (mostly) in real-time.
Mark out
Staking is the process of allocating cryptocurrency to a proof-of-stake network — like Ethereum, Cardano, or Solana — to secure the blockchain and validate transactions on the network. Locking coins into a blockchain’s smart contract for the purpose of staking often results in a lower but reliable return.
Remarkablemany of these smart contract platforms have an unlock period for staked assets. This means that once one decides to withdraw those funds, it can take days or weeks to withdraw coins, which would slow down the farming process.
loan
Lending cryptocurrencies to other users is a common practice in DeFi. By lending your tokens to borrowers, you acquire the right to collect interest from them.
This mirrors the traditional financial system, but interest rates are set almost entirely by supply and demand dynamics and not by third party institutions.
Provision of Liquidity
Decentralized exchanges (DEXs) often use an automated market making system (AMM) focused on pools of liquidity. Liquidity providers contribute to these pools by depositing cryptocurrencies that traders can trade for while paying a small fee for the service. These fees are then distributed to all liquidity providers.
Rewards from liquidity pools can be paid in the form of pooled assets (e.g. DAI in an ETH/DAI pool) or in the form of a platform’s unique token (e.g. UNI for Uniswap). Some protocols even issue Liquidity Provider (LP) tokens to depositors, and these LP tokens can be staked on the platform for compound rewards.
yield farming process
Imagine a lending protocol that offers 5% APY on the DAI stablecoin. A user can deposit 100 DAI to benefit from this return.
However, you learn that a DEX offers 8.5% APY for DAI deposited into a liquidity pool. As the user wants to optimize their crypto rewards, they move their 100 DAI from the lending log to the DEX.
If the DEX’s DAI APY ever falls below 5%, they can return their original purchases plus earnings back into the credit log. In doing so, they become yield farmers.
What Are Some Dapps That Can Be Used For Yield Farming?
Mark out is possible on multiple blockchains including Ethereum, Cardano, Polkadot, Solana, Polygon and Avalanche. Unlike other revenue-generating practices, staking does not always rely on specific decentralized applications (dApps) and can instead be done through a wallet or by directly interacting with a smart contract. Some platforms even offer staking by delegating when users are unable to allocate enough funds to meet the minimum wagering requirements.
For loantwo of the most popular platforms are Maker, which offers over-collateralised crypto-backed loans of its DAI stablecoin, and Aave, which offers a rich marketplace for lending and borrowing many different cryptocurrencies.
Decentralized exchanges using AMMs create the opportunity for users provide liquidity. These include Curves stablecoin DEX, Uniswap, Sushiswap, Compound and Balancer. Each differs in how they reward their users for becoming a liquidity provider, and all offer rewards in their own tokens to encourage further use of the platforms.
Additionally, three dapp aggregators are worth mentioning that can be used to track blockchain data and find the best farming opportunities:
- DappRadar – a website that collects information about dapps by blockchain and category.
- DeFi Flame And DeFi Pulse – Sites that specifically focus on DeFi platforms and track important information such as Total Volume Locked (TVL) and Yield offers.
Basics of yield farming
- Yield farming is similar to finding the bank account with the highest interest rate; it is about choosing DeFi protocols with high profits and locking crypto in them.
- There are three main ways to generate income from using cryptocurrency: staking, lending, and providing liquidity.
- While staking can be done through direct interaction with a blockchain platform or through delegation, lending is done through protocols like Maker and Aave, and DEXs like Curve and Uniswap offer the ability to provide liquidity to generate income.
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