Learn more about the different ways to manage yields.
Where do crypto earnings come from?
The concept of yield farming in crypto refers to the practice of lending out your crypto assets to earn interest on them. This can be done through a variety of different platforms and protocols, including lending platforms, staking platforms, liquidity pools, and even some smart contracts.
In general, yield farming refers to the practice of earning interest on your crypto assets by lending or staking them. This is a great way to earn passive income from your crypto holdings, and it can also help you grow your portfolio.
Income can be generated through a variety of different means such as trading fees, borrowing and borrowing fees, smart contracts (strategy years), log fees and rewards programs. Below, we break down how crypto generates income and explain the possible caveats to participating in each:
Trading Fees APY (DEX)
A decentralized exchange (DEX) is a type of cryptocurrency exchange where buyers and sellers trade directly with each other via pools of liquidity without the need for a third party or central authority. These exchanges are peer-to-peer, meaning all transactions are verified and stored on a public blockchain, providing greater transparency and security. DEXs are often more secure than centralized exchanges and less prone to bank runs, as we saw with the entire FTX fiasco recently.
Liquidity providers, which are often the driving force behind a DEX, earn trading fees for lending their tokens for others to trade. It does this by providing liquidity to an order book, or liquidity pool, that allows traders to buy and sell tokens quickly and easily. Liquidity providers are compensated for their efforts by receiving a portion of the trading fees generated from each exchange transaction. This gives liquidity providers an incentive to keep their tokens available for exchange, which helps ensure the liquidity needed for smooth and efficient trading.
Below you can see the TVL, 24-hour volume and 24-hour fees generated by the USDC/ETH liquidity pool Uniswap. All of these fees go directly to the liquidity providers:
https://info.uniswap.org/#/pools/0x88e6a0c2ddd26feeb64f039a2c41296fcb3f5640
The provision of liquidity involves the risk that the liquidity provider may suffer a temporary loss. A temporary loss occurs when the price of the asset provided as liquidity moves away from the price at which the liquidity provider entered the market. This can result in the liquidity provider suffering losses even if they close their position.
These losses can be amplified when the liquidity provider provides liquidity to multiple assets at the same time, as the temporary loss in one asset could offset gains in another. In addition, the provision of liquidity may also involve a risk of slippage, which can occur if the liquidity provider is trading in a highly volatile market. Slippage occurs when the market moves so fast that the liquidity provider’s orders are filled at a worse price than expected, resulting in a loss of potential profits.
Rental Fees APY
A decentralized pool-based cryptocurrency lending and borrowing protocol works by allowing users to borrow and lend digital assets from a shared pool of assets. The protocol uses smart contracts to facilitate the lending and borrowing process and ensure that lending terms are met. All loans are stored in the common pool and are accessible to all users. The protocol aims to ensure that all transactions are secure and transparent, giving users the confidence to lend and borrow money.
Users can only participate in the credit side of the protocol and earn an APY, thereby not exposing themselves to risk by borrowing against their assets. For example, you could lend out USDT SPIRIT and earn 2.23% APY without taking out a loan:
https://app.aave.com/
Protocol Fees APY
Some protocols choose to share revenue with their users. Sushiswap, for example, charges a 0.3% fee on all trading pairs, with liquidity providers receiving 0.25% and xSUSHI token holders receiving the remaining 0.05%.
Once MELD starts generating revenue, a small percentage is allocated for MELD stakers, similar to Sushiswap. Stay tuned!
Strategies (year)
Yearn Finance uses a variety of strategies to maximize profits for its users. These include the use of automated portfolio rebalancing and dynamic vault strategies that use yield farming, arbitrage and lending to generate returns. The platform also employs a liquidity mining program that rewards users for providing liquidity to the platform’s pools. Yearn has integrated a range of DeFi protocols and platforms to gain access to a variety of assets and optimize returns.
For example, the Yearn USDT Vault (4.84% APY) has 3 different strategies associated with it:
https://yearn.finance/#/vault/0x3B27F92C0e212C671EA351827EDF93DB27cc0c65
reward programs
One of the last ways crypto income is generated is through rewards programs. These are simply a protocol or partner offering a token (usually their own) as a reward for participating in the position. This is done to encourage users to move their liquidity.
REPORT strikeFor example, offers players MELD tokens for staking MELD for 6 or 12 months. This may be added to log fees in the future!
Another example of a rewards program is our partners; wing rider:
https://app.wingriders.com/farming/all-farms
This position offers liquidity providers to the ADA/MELD liquidity pool with WRT tokens – currently earning ~29.4% APY, as broken down below:
Pool fees APR: 2.926%
Pool Staking APR: 2.446%
Farm APR: 5.044%
APR increase: 18.978%
Banks use their customers’ liquidity to generate income by investing it in various financial instruments such as bonds, stocks and other investments. The bank then collects a return on those investments, which is ultimately the return they earn. However, banks generally give very little back to the original liquidity provider as the returns they receive on their investments are typically much higher than the interest they pay back to depositors. This allows them to keep most of the profits they make from clients’ funds.
These players are fundamentally opposed to DeFi because the majority of those returns in DeFi go directly to the user providing the money, rather than the middlemen. This means that the banks cannot make as much money from their customers’ money. As a result, they are less willing to support DeFi projects.
There is a big wall between these centralized players and DeFi, and it should be interesting to see how the gap is shrinking over time.
Diploma
If you have any thoughts/comments on yield farming or just want to start a discussion with one of our community members or ambassadors on the subject, come join us discord and start the conversation!
We think it is important for everyone to take control of their financial life and have equal access to financial tools used by professionals, not just centralized institutions, governments or the 1%. We want to bring financial freedom and control to the masses, including the unbanked.
Our long-term goal is to provide access to these tools to the $15 trillion currently excluded from the global economy, including 2 billion people worldwide who are either underserved or unable to access banking services at all. These are the people who pay the highest fees, get the worst customer service, and are the ones who experience the most problems.
Our vision is to create an ecosystem that empowers individuals to take back financial control by providing them with the tools and services they need to manage their money on their terms. Whether it’s creating a Collateralized Debt Position (CDP) with cryptocurrency, earning an interest yield for lending fiat to borrowers, or even participating in rewards programs, we strive to provide our users with the features they need, to manage their own financial lives.
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