If you are a seasoned crypto trader, you have come across the term “yield farming” countless times in the recent past. This topic is trending since it makes investing in decentralized finance an incredibly profitable practice. Keep reading to learn about this cryptocurrency trading approach and how you can benefit from it.
Yield farming refers to a mechanism whereby yield farming protocols incentivize the farmers to lock up or stake their digital assets in smart contracts on a liquidity pool. The incentives can be in the form of interest from lenders, a fraction of transaction fees, or a governance token.
As the number of investors that add funds to a particular liquidity pool increases, the issued returns’ value also increases.
Ethereum blockchain and smart contracts are designed with the needs of yield farmers in mind. So, most informed followers of this practice rely on multiple techniques to gain more profits than their counterparts in the same industry. In other words, popular De-Fi protocols currently operate on Ethereum and offer liquidity mining.
As we have seen, farming primarily involves helping the crypto lending ecosystem grow by contributing your digital assets to the system to make huge profits.
Staking, on the other hand, refers to participating in a network of governance. In most cases, stakers make decisions that influence the creation of the blocks that form the blockchain for Proof of Stake coins.
In short, yield farming is a more complex and vague process, as you are only providing liquidity to be lent to others. Staking involves having the required authority to determine how your resources are used on the protocol.
This common term, “Liquidity pool,” refers to a collection of crypto tokens locked into smart contracts. They provide the liquidity that De-Fi protocols require to remain operational 24/7.
This was one of the first governance tokens that Compound began to issue to its platform users as additional compensation. Today, most farming protocols have adopted the same strategy and reward their liquidity providers with various types of governance coins to trade on decentralized and centralized exchanges.
Currently, ERC-20 tokens are the best well-known De-Fi tokens. They are designed on the Ethereum platform and used on its own.
You can share and exchange these tokens for others. Moreover, you can transfer them to your compatible crypto-wallet.
The amount you can earn depends on the APY, compounding, transaction fee, and more.
Since yield farmers must go to DEX liquidity pools to trade, liquidity mining significantly influences the earnings. New tokens typically have a high APY that ranges between 1% daily and 6% daily, which helps to attract investors to provide liquidity.
Without compounding, if the liquidity mining is 1% daily, the farmer earns 365% profit annually.
Please note that we assume here that the LP token will remain stable throughout the year.
With compounding, a farmer who earns 1% daily can expect 101%^365-1 = 3,678%. The APY can exceed hundreds of billions at 6% compounded hourly.
However, remember that these projects run on public blockchains. So, during the yielding processes, the users will likely have to pay slots of transaction costs, reducing the earnings.
However, you can maximize your yield farming profits. Some of the ways to do this are:
Yield farming has costly risks that any user with an objective of maximizing returns needs to understand and mitigate. Cryptocurrencies are highly volatile, so buying and holding them is highly risky. In 2017, Bitcoin hit $ 20,000 USD. In the recent past, it was less than $ 3.000. Today, the price has reached over $50,000.
Other than this, yield farming faces the following unique risks:
The rug-and-pull presents the highest risks for liquidity mining. It describes a developer who has the sole intention of stealing the liquidity pool when launching the investment project.
The good news is that yield farmers can reduce these risks by:
If you are looking for the top De-Fi platforms that you can use in 2021 to optimize the returns on your staked funds, then here is a list of the top options to consider.
Yield farming has been exceptionally popular in the DeFi space since 2020 for good reasons. Crypto asset holders are pleased to learn that it offers them lots of opportunities to generate higher returns. Although it is a risky endeavor, yield farmers who do due diligence before investing continue to enjoy it as a profitable money-making practice.