output farmers who want to increase their give output can employ more building complex tactics. For example, return farmers can constantly shift their cryptos between multiple loan platforms to optimize their gains .
Quick facts:
- Yield farming is the process of token holders maximizing rewards across various DeFi platforms.
- Yield farmers provide liquidity to various token pairs and earn rewards in cryptocurrencies.
- Top yield farming protocols include Aave, Curve Finance, Uniswap and many others.
- Yield farming can be a risky practice due to price volatility, rug pulls, smart contract hacks and more.
How does yield farming work?
output farming allows investors to earn yield by putting coins or tokens in a decentralized application, or dApp. Examples of dApps include crypto wallets, DEXs, decentralized social media and more .
succumb farmers generally use decentralized exchanges ( DEXs ) to lend, borrow or stake coins to earn concern and speculate on price swings. give farming across DeFi is facilitated by ache contracts — pieces of code that automatize fiscal agreements between two or more parties.
Types of yield farming:
- Liquidity provider: Users deposit two coins to a DEX to provide trading liquidity. Exchanges charge a small fee to swap the two tokens which is paid to liquidity providers. This fee can sometimes be paid in new liquidity pool (LP) tokens.
- Lending: Coin or token holders can lend crypto to borrowers through a smart contract and earn yield from interest paid on the loan.
- Borrowing: Farmers can use one token as collateral and receive a loan of another. Users can then farm yield with the borrowed coins. This way, the farmer keeps their initial holding, which may increase in value over time, while also earning yield on their borrowed coins.
- Staking: There are two forms of staking in the world of DeFi. The main form is on proof-of-stake blockchains, where a user is paid interest to pledge their tokens to the network to provide security. The second is to stake LP tokens earned from supplying a DEX with liquidity. This allows users to earn yield twice, as they are paid for supplying liquidity in LP tokens which they can then stake to earn more yield.
Calculating yield farming returns
Expected yield returns are normally annualized. The prospective returns are calculated over the course of a year .
Two often-used measurements are annual percentage rate ( APR ) and annual share output ( APY ). APR does not account for compounding — reinvesting gains to generate larger returns — but APY does .
Keep in heed that the two measurements are merely projections and estimations. even short-run advantages are difficult to forecast with accuracy. Why ? move over farming is a highly competitive, fast-paced industry with quickly changing incentives .
If a yield farming strategy succeeds for a while, other farmers will flock to take advantage of it, and it will ultimately stop yielding meaning returns .
Because APR and APY are outmode market metrics, DeFi will have to construct its own net income calculations. Weekly or even daily expected returns may make more sense due to DeFi ’ s rapid yard .
Popular yield farming protocols
Curve Finance
Curve is the largest DeFi chopine in terms of sum rate locked, with closely $ 19 billion on the platform. With its own market-making algorithm, the Curve Finance platform makes greater use of interlock funds than any early DeFi chopine — a beneficial strategy for both swappers and fluidity suppliers .
Curve provides a large number of stablecoin pools with good APRs that are tied to fiat cash. Curve keeps its APRs gamey, ranging from 1.9 % ( for liquid tokens ) to 32 %. adenine hanker as the tokens don ’ t lose their peg, stablecoin pools are quite condom. impermanent loss may be wholly avoided because their costs will not alter drastically in comparison to each other. Curve, like all DEXs, carries the danger of temp passing and bright contract failure .
Curve besides has its own token, CRV, that is used for administration for the Curve DAO .
Aave
Aave is one of the most wide used stablecoin yield farming platforms, with over $ 14 billion in value locked up and a market worth of over $ 3.4 billion .
Aave besides has its own native nominal, AAVE. This nominal incentivizes users to use the network by providing benefits such as fee savings and administration vote power .
It is common to find liquid pools working together when it comes to yield farm. The Gemini dollar, which has a deposit APY of 6.98 % and a borrow APY of 9.69 %, is the highest-earning stablecoin accessible on Aave .
Uniswap
Uniswap is a DEX system that enables token exchanges with no entrust. Liquidity providers invest the equivalent of two tokens to create a market. Traders can then trade against the liquidity consortium. In reelect for providing fluidity, liquidity providers get fees from trades that take place in their pond .
due to its frictionless nature, Uniswap has become one of the most popular platforms for trustless nominal swaps. This is useful for high-yield agrarian systems. Uniswap besides has its own DAO administration token, UNI .
PancakeSwap
PancakeSwap works similarly to Uniswap, however, PancakeSwap runs on the Binance Smart Chain ( BSC ) network rather than on Ethereum. It besides includes a few extra gamification-focused features. BSC keepsake exchanges, interest-earning impale pools, non-fungible tokens ( NFTs ) and even a gamble game in which players guess the future price of Binance Coin ( BNB ) are all available on PancakeSwap .
PancakeSwap is submit to the same risks as Uniswap, such as irregular passing due to big price fluctuations and fresh contract failure. Many of the tokens in PancakeSwap pools have minor market capitalizations, putting them in risk of temp loss .
PancakeSwap has its own token called CAKE that can be used on the platform and besides used to vote on proposals for the platform .
Risks of yield farming
yield farm is a complicated process that exposes both borrowers and lenders to fiscal risk. When markets are disruptive, exploiter face an increased risk of temp loss and price slippage. Some risks associated with concede farming are as follows :
Rug pulls
Rug Pulls are a form of an exit victimize in which a cryptocurrency developer collects investor cash for a visualize and then abandons it without repaying the funds to the investors. Rug pulls and other exit scams, which yield farmers are particularly vulnerable to, accounted for about 99 % of big fraud during the second half of 2020, according to a CipherTrace inquiry reputation .
Regulatory risk
Cryptocurrency rule is still shrouded in doubt. The Securities and Exchange Commission has declared that some digital assets are securities, putting them within its jurisdiction and allowing it to regulate them. submit regulators have already issued discontinue and abstain orders against centralize crypto lending sites like BlockFi, Celsius and others. DeFi lending and borrow ecosystems could take a hit if the SEC declares them to be securities.
Read more: Events Timeline
While this is true, DeFi is designed to be immune to any central assurance, including government regulations .
Volatility
volatility is the degree to which the monetary value of an investing moves in either commission. A volatile investment is one that has a large price swing over a light period of time. While tokens are locked up, their rate may drop or rise, and this is a huge risk to yield farmers specially when the crypto markets experience a hold campaign .
What is impermanent loss?
During periods of high volatility, liquid providers can experience impermanent loss. This occurs when the monetary value of a keepsake in a liquidity pool changes, subsequently changing the ratio of tokens in the pool to stabilize its total value .
Example :
Alice deposits 1 ETH and 2,620 DAI ( US dollar stablecoins : 1 DAI = $ 1 ) into a liquid pool because the rate of one ether is $ 2,620 ( at the time of writing ). Say the pool only has three other liquidity providers who have each deposited the same sum to the pool, bringing the entire rate of the pool to 4 ETH and 10,480 DAI, or $ 20,960 .
Each of these liquidity providers is entitled to 25 % of the pool ’ second funds. If they wanted to withdraw at stream prices, they would each receive 1 ETH and 2,620 DAI. But what happens when the price of ETH falls ?
If the price of ETH starts to drop, that means traders are selling ETH for DAI. This causes the ratio of the pool to shift thus that it is more ETH heavy. Alice ’ s parcel of the pool would still be 25 %, but she would immediately have a higher ratio of ETH to DAI. The value of her 25 % share of the pond would now be worth less than when she initially deposited her funds because traders were selling their ETH at a lower value than when Alice added liquidity to the consortium .
This is called an impermanent personnel casualty because the loss is only realized if the liquidity is withdrawn from the pool. If a liquidity provider decides to keep their funds in the pool, the liquid respect may or may not break even over time. In some cases, the fees earned from providing liquid can offset impermanent losses .
Smart contract hacks
Most of the hazards associated with yield farming are related to the smart contracts that underpin them. The security of these contracts is being improved via better code vet and third-party audit, however, hacks in DeFi are still common .
DeFi users should conduct research and use due diligence prior to using any platform .
Frequently asked questions
Is yield farming profitable?
Yes. however, it depends on how much money and attempt you ’ re will to put into yield farming. Although certain bad strategies promise hearty returns, they broadly require a exhaustive appreciation of DeFi platforms, protocols and complicated investing chains to be most effective .
If you ’ ra searching for a way to make some passive income without investing a draw of money, try placing some of your cryptocurrencies into a tested and trustworthy chopine or fluidity pool and seeing how much it earns. After you ’ ve formed this foundation garment and developed confidence, you may move on to other investments or even buy tokens directly .
Is yield farming risky?
hazard farming carries a number of risks that investors should understand before starting. Scams, hacks and losses due to volatility are not uncommon in the DeFi output farming space. The inaugural step for anyone wish to use DeFi is to research the most trust and screen platforms .
Further reading
concern Rate Swaps Will Be ‘ Catalyst for New Era of DeFi, ’ Says Voltz CEO
DeFi 2.0 and Liquidity Incentivization
Celsius CEO Mashinsky : The 8.8 % return We Pay on Stablecoins is True Value of USD
Get educated. Check out Proof-of-Work vs. Proof-of-Stake, The Investor ’ s Guide to NFTs, The Investor ’ s Guide to DeFi, The Investor ’ s Guide to the Metaverse or the guide to Solana .
This is not an sanction of any undertaking, and should not be interpreted as investment advice. This Guide is for educational purposes merely .
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Luke Conwayeditor, Evergreen Content
As Editor of Evergreen Content at Blockworks, Luke Conway oversees the universe of comprehensive educational guides on all things crypto to help users navigate the space. Before Blockworks he worked as an associate editor for Investopedia, managing broke reviews and a cryptocurrency news desk .
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