Utilizing decentralized finance (DeFi) to maximize returns is known as yield farming. On a DeFi platform, users can lend or borrow cryptocurrency and receive cryptocurrency in exchange.
Farmers interested in increasing their yield output can use more sophisticated strategies. For instance, yield farmers can continuously switch their cryptocurrency holdings between different loan platforms to maximize their profits.
- Token holders who practice yield farming maximize rewards on different DeFi platforms.
- In exchange for the liquidity they provide to different token pairs, yield farmers are paid in cryptocurrencies.
- Aave, Curve Finance, Uniswap, and many other high-yield farming protocols are examples.
- Because of price volatility, rug pulls, smart contract hacks, and other factors, yield farming can be risky.
How does farming for yield work?
By putting coins or tokens in a decentralized application, or dApp, Defi yield farming enables investors to earn yield. Cryptographic wallets, DEXs, decentralized social media, and other applications are examples of dApps.
Yield farmers typically use decentralized exchanges (DEXs) to lend, borrow, or stake coins to earn interest and speculate on price fluctuations. Smart contracts are pieces of code that automate financial agreements between two or more parties and enable yield farming across DeFi.
Yield Farming Techniques:
Provider of liquidity: Users deposit two coins to a DEX to provide trading liquidity. To swap the two tokens, exchanges charge a small fee to liquidity providers. New liquidity pool (LP) tokens can sometimes be used to pay this fee.
Lending: Coin or token owners can use a smart contract to lend cryptocurrency to borrowers, earning yield from the interest charged.
Borrowing: Farmers may borrow another token by pledging one as collateral. The borrowed coins can then be used to increase farming yield. In this manner, the farmer retains their initial investment, which may rise in value over time, and earns profit on the coins they borrowed.
Staking: In the world of DeFi, there are two types of staking. The primary implementation is on blockchains using proof-of-stake, where a user receives interest in exchange for pledging their tokens to the network as security. The second is to stake LP tokens obtained by providing liquidity to a DEX. Because they are compensated for providing liquidity in LP tokens, which they can later stake to earn more yield, this enables users to make yield twice.
Calculating Farming Yield Returns
Typically, expected yield returns are annualized. A year’s worth of calculations goes into calculating the potential returns.
Annual percentage yield (APR) and annual percentage rate (APR) are two frequently used measurements (APY). APR does not take compounding—reinvesting profits to produce higher returns—into account, but APY does.
Remember that the two measurements are only hypotheses and guesses. Even immediate benefits are challenging to predict with accuracy. Why? A fast-paced, fiercely competitive sector with constantly shifting incentives is yield farming.
A farming strategy that increases yields for a while will eventually stop producing significant returns because other farmers will start using it.
APR and APY are outdated market metrics, so DeFi will need to develop its method of calculating profit. Due to DeFi’s rapid pace, weekly or daily expected returns might make more sense.
Standard Farming Practices for Yield
With almost $19 billion on the platform, Curve is the DeFi platform with the most significant total value locked. The Curve Finance platform utilizes locked funds more than any other DeFi platform, thanks to its unique market-making algorithm, which is advantageous for both swappers and liquidity providers.
Curve offers a comprehensive list of stablecoin pools with reasonable APRs connected to fiat money. With APRs ranging from 1.9 percent (for liquid tokens) to 32 percent, Curve maintains its high rates. Stablecoin pools are pretty secure if the tokens don’t lose their peg. Because their costs won’t change significantly about one another, the impermanent loss can be avoided entirely. Like all DEXs, Curve risked momentary loss and failed smart contracts.
Additionally, Curve has a proprietary token called CRV that it uses to manage the Curve DAO.
One of the most popular stablecoin yield farming platforms is Aave which has more than $14 billion in value locked up and a market value of more than $3.4 billion.
Aave’s native token is also available. This token encourages users to use the network by offering advantages like fee reductions and voting power for governance.
When it comes to yield farming, liquidity pools frequently collaborate. The highest-earning stablecoin available on Aave is the Gemini dollar, which has an APY of 6.98 percent for deposits and 9.69 percent for borrowing.
A DEX system called Uniswap enables untrusted token exchanges. To establish a market, liquidity providers put two tokens in the equivalent. Then, traders can make transactions using the liquidity pool. Liquidity providers receive fees from trades in their collection as payment for their services.
Uniswap has emerged as one of the most widely used platforms for frictionless token swaps due to its frictionless design. For high-yield agricultural systems, this is helpful. Additionally, Uniswap has a DAO governance token called UNI.
While PancakeSwap functions similarly to Uniswap, it utilizes the Binance Smart Chain (BSC) network as opposed to Ethereum. A few additional gamification-related features are also included. PancakeSwap offers BSC token exchanges, interest-earning staking pools, non-fungible tokens (NFTs), and even a gambling game where players must predict the future value of Binance Coin (BNB).
The same risks that Uniswap is exposed to, such as temporary loss due to significant price fluctuations and smart contract failure, also apply to PancakeSwap. Since many of the tokens in PancakeSwap pools have small market capitalizations, they could temporarily lose value.
CAKE, PancakeSwap’s proprietary token, can be used on the platform and is also used to cast votes for changes to the platform.
Frequently Asked Questions
Is farming for yield profitable?
Yes. However, it all depends on how much you’re willing to invest in yield farming in terms of money and time. Even though some high-risk strategies promise sizable returns, they typically work best when the user has a solid understanding of DeFi platforms, protocols, and complex investment chains.
Try putting some of your cryptocurrencies into a tried-and-true platform or liquidity pool to see how much it earns if you’re looking for a way to generate passive income without making a significant financial commitment. Once you’ve established this base and gained confidence, you can move on to other investments or make direct token purchases.
Is farming for yield risky?
Investors should be aware of the risks associated with risk farming before beginning. In the DeFi yield farming industry, scams, hacks, and losses from volatility are not unusual occurrences. Anyone interested in using DeFi should look at the most reliable and tried platforms.