What Is Yield Farming In DeFi and How Does It Work?
Perhaps one of the most confusing terms used in decentralized finance (DeFi) for those new to this area is “yield farming”. One would be forgiven for failing to see the connection between the agricultural practice of growing crops and this crypto-specific activity.
However, just like real-life farming, yield farming also involves dedication, specialist knowledge and care. As such, this practice is not for everyone and should only be undertaken by experienced digital asset investors.
In simplest terms, yield farming (also known as “liquidity mining”) is the practice of staking or lending one’s digital assets in return for rewards. Those engaging in yield farming are called “liquidity providers” (or LPs for short), since their main role is to provide liquidity to their chosen DeFi protocol to allow it to function efficiently.
LPs are an important part of the DeFi ecosystem, but just like real-life farming, finding the richest soil to grow the most profitable crops is a time-consuming process. In the fast-moving world of DeFi, yields and token prices can fluctuate significantly within a short space of time, so having a strong grasp of how the ecosystem works and an eye on the market movements is a must.
The process of earning rewards
When engaging in yield farming, LPs deposit their digital assets into a smart contract-based “liquidity pool”, where they are usually locked for a certain period of time in return for rewards, typically paid in the form of governance tokens, a percentage of transaction fees, or interest from lenders. These returns, expressed as an annual percentage yield (APY), can then be deposited into another liquidity pool to earn more rewards, ad infinitum.
One way LPs can engage in yield farming is by providing liquidity to decentralized exchanges (DEXs), which is crucial for the whole system to work seamlessly and efficiently. An LP can contribute to a liquidity pool for different cryptocurrencies on an exchange, with some offering APYs in excess of 100% or even higher, depending on the DEX and the digital asset. LPs are usually rewarded based on the proportion of the liquidity pool they control.
Apart from DEXs, yield farmers can also participate in lending and borrowing platforms, which offer a unique way for lenders to earn different tokens, and by staking their tokens into a smart contract to earn passive rewards.
YIELD App is an example of a staking platform where users earn rewards for holding the native token, YLD, in their wallets. By simply holding YLD in their wallets, users earn up to an additional 10% on their other invested assets, depending on the amount of YLD held in the wallet. For example, the base APY on USDT and USDC invested with YIELD App is 10.5%, but holding YLD in one’s wallet can boost this up to 20.5%. This type of model incentivizes users to hold a protocol’s native token, limiting its market supply and thereby increasing demand and reducing selling pressure.
The risks of yield farming
However, while the returns available from yield farming can be extremely lucrative compared to anything available in traditional finance, the process can be time consuming and often risky. This area of finance remains unregulated and immature and mistakes are easy to make, so yield farmers must be aware they stand the risk of losing all their funds.
Risks include smart contract exploits, price volatility, and impermanent loss. The latter is linked to price volatility, since it occurs when the price of the tokens in a liquidity pool changes compared to when they were deposited in the pool. If the price of a token drops by a significant amount by the time the yield farmer needs to withdraw their tokens, the impermanent loss can also be hefty.
On top of this, as already mentioned, it is easy to make mistakes during the learning process. For example, inexperienced yield farmers can face high transaction fees, which makes the whole process of liquidity mining inefficient or unprofitable. And finally, not everyone is willing to commit the time and dedication required to learn the ins and outs of yield farming.
YIELD App’s solution
YIELD App is aware of the risks and complexities involved in liquidity mining and that this practice is not a suitable choice for many digital asset investors. However, it believes all investors everywhere across the world should have access to the high APYs available from DeFi.
To facilitate this, YIELD App’s dedicated and experienced team seeks out the optimal APYs available among DeFi products to offer its users market-leading APYs on stablecoins (USDC and USDT), ETH and BTC. These rates adjust periodically to ensure funds remain safe, allowing users the peace of mind that yield farming doesn’t offer. This allows YIELD App to offer the opportunities available from DeFi to anyone, anywhere, regardless of their financial or technical knowledge.
About the Company: YIELD App believes that everyone should have access to the best investment opportunities. Its mission is to unlock the full potential of digital assets, combine them with the most rewarding opportunities available across all financial markets and make these available to the world. To achieve this, the company provides an innovative wealth management platform that bridges traditional and decentralized finance in the easiest way possible. For more information, visit www.yield.app
Company: YIELD App