What Is Yield Farming? What You Need To Know

Yield farming is the technique of maximizing returns through the use of decentralized finance (DeFi). On a DeFi network, users lend or borrow cryptocurrency and receive cryptocurrency in exchange for their services.

Farmers that desire to boost their crop production can use more complex strategies. Yield farmers, for example, might continually shift their cryptos between several lending platforms to maximize their profits.

How does yield farming work？

Yield farming allows investors to earn a return by investing in a decentralized application, or dApp. Crypto wallets, DEXs, decentralized social media, and other dApps are examples.

Decentralized exchanges (DEXs) are commonly used by yield farmers to lend, borrow, or stake coins in order to earn interest and speculate on price volatility. Smart contracts, which automate financial agreements between two or more parties, promote yield farming via DeFi.

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

Annualized yield returns are commonly used. The anticipated returns are estimated over the course of a year.

Annual percentage rate (APR) and annual percentage yield (APR) are two often used measures (APY). APR does not take into account compounding (reinvesting gains to create higher returns), whereas APY does.

Remember that the two measures are only forecasts and estimates. Even short-term benefits are difficult to predict with precision. Why？ Yield farming is a fiercely competitive, fast-paced sector with constantly shifting incentives.

If a yield farming approach works for a while, other farmers will swarm to use it, and it will eventually stop producing large profits.

DeFi will have to develop its own profit calculations because APR and APY are outdated market measurements. Because of DeFi's quick speed, weekly or even daily predicted returns may make more sense.

Popular yield farming protocols

Curve Finance

Curve has almost $19 billion in total value locked on its network, making it the largest DeFi platform in terms of total value locked. The Curve Finance platform uses locked funds more than any other DeFi platform, thanks to its proprietary market-making algorithm – a win-win strategy for both swappers and liquidity providers.

Curve offers a comprehensive list of stablecoin pools with attractive APRs that are linked to fiat currency. Curve maintains high APRs ranging from 1.9% (for liquid tokens) to 32%. Stablecoin pools are quite safe as long as the tokens do not lose their peg. Impermanent loss can be completely prevented because their costs do not differ much from one another. Curve, like all DEXs, risks momentary loss and smart contract failure.

Curve has its own token, CRV, which is used to manage the Curve DAO.

Aave

Aave is one of the most popular stablecoin yield farming platforms, with more than $14 billion in value locked up and a market capitalization of more than $3.4 billion.

AAVE is also Aave's native token. This token encourages users to use the network by offering incentives such as fee reductions and voting power in governance.

Uniswap

Uniswap is a DEX system that allows for trustless token trades. To build a market, liquidity providers invest the equivalent of two tokens. The liquidity pool is then traded against by traders. Liquidity providers receive fees from trades that occur in their pool in exchange for providing liquidity.

Uniswap has become one of the most popular platforms for trustless token swaps due to its frictionless nature. This is beneficial in high-yielding agricultural systems. UNI, Uniswap's DAO governance token, is also available.

PancakeSwap

PancakeSwap functions similarly to Uniswap, but it runs on the Binance Smart Chain (BSC) network rather than the Ethereum network. It also has a few more gamification-focused features. PancakeSwap offers BSC token swaps, interest-earning staking pools, non-fungible tokens (NFTs), and even a gambling game in which users anticipate the future price of Binance Coin (BNB).

PancakeSwap faces the same risks as Uniswap, including temporary losses caused by large price changes and smart contract failure. Many of the tokens in PancakeSwap pools have low market capitalizations, putting them at risk of short-term loss.

PancakeSwap has its own token, CAKE, which can be used on the platform and also used to vote on platform proposals.

Risks of yield farming

Yield farming is a complex operation that puts both borrowers and lenders at risk. Users incur a higher risk of momentary loss and price slippage when markets are volatile. The following are some of the risks linked with yield farming:

Rug pulls

Rug Pulls are a type of exit scam in which a cryptocurrency developer obtains investor funds for a project and then abandons it without repaying the investors' monies. According to a CipherTrace study report, rug pulls and other exit scams, to which yield farmers are particularly vulnerable, contributed for around 99% of large fraud during the second half of 2020.

Regulatory risk

The regulation of cryptocurrencies remains hazy. The Securities and Exchange Commission has decided that certain digital assets are securities, bringing them under its jurisdiction and granting it the authority to regulate them. State regulators have already issued cease and desist orders to centralized cryptocurrency lending platforms such as BlockFi, Celsius, and others. If the SEC declares DeFi lending and borrowing ecosystems to be securities, the ecosystems could suffer.

While this is correct, DeFi is designed to be independent of any central authority, including government regulations.

Volatility

The degree to which the price of an investment changes in either direction is referred to as volatility. A volatile investment is one that has a significant price swing in a short period of time. While tokens are locked up, their value may fall or rise, posing a significant risk to yield farmers, particularly during a bear market in the crypto markets.

Is yield farming risky？

Risk farming entails a lot of dangers that investors should be aware of before getting started. In the DeFi yield farming space, scams, hacks, and losses due to volatility are common. The first step for anyone interested in using DeFi is to research the most reliable and tested systems.

As a reminder, WikiBit is ready to help you search the qualifications and reputation of projects in a bid to protect you from hidden dangers in this risky industry!