What is Yield Farming? Useful guide with examples.
DeFi (Decentralized Finance)
is an alternative to the traditional financial system and is becoming increasingly popular. This is partly due to the emergence of a new hype in the crypto world called yield farming. With this method, you can make money as a crypto trader without having to sell your crypto at a profit. We'll explain everything about yield farming in this article.
What is yield farming?
Yield farming is a method where various strategies are used to optimize the return of cryptocurrencies. This may sound a bit vague now, although it is quite easy to understand. It is a process where users provide liquidity to DeFi protocols, and are rewarded with a quid pro quo, in the form of tokens. Due to the increasingly popular DeFi market, yield farming is also becoming more common. The original idea of yield farming was quite simple: connect lenders and borrowers. The platforms use a liquidity pooling system where lenders can offer tokens and coins to the market, and other users can borrow them.
Liquidity providers are remunerated in tokens. Users who borrow money actually pay transaction fees and an interest rate. The returns are often so high that it provides an incentive for many users to provide liquidity, in order to bring in the financial resources of a new decentralized funding protocol.
Other forms of farming in the crypto world
Yield farming is not the only form of farming you can encounter within the crypto world. When we talk about crypto-currencies
, farming involves depositing tokens or crypto tokens into a liquidity pool of a DeFi protocol in order to earn rewards.
In this case, the users who lend their tokens or crypto tokens are rewarded in the form of governance tokens. These tokens allow the holders to vote on decisions that need to be done for the protocol. The best-known platforms that have offered a governance token to liquidity providers are Compound (COMP) and Balancer (BAL).
The yields are often very attractive to liquidity providers, as DeFi protocols cannot continue to grow without the funds that users provide.
Which projects do yield farming?
is a platform for borrowing and lending tokens and crypto tokens, where the interest rate is determined automatically by an algorithm. Users can earn their interest in the form of the COMP governance token. Want to buy Compound (COMP)? You can do so on Coinmerce's crypto exchange.
is a pioneer in decentralized lending that allows users to lock in cryptocurrencies as collateral to borrow DAI. This is a stablecoin which is based on the US dollar.
is perhaps the best-known decentralized borrowing and lending protocol, where users can borrow tokens and coins and earn compound interest for the loan in the form of the AAVE (formerly LEND) token. Aave is also known for facilitating flash loans and delegated credit, where loans can be made to borrowers without collateral. Want to buy Aave (AAVE)? You can do so on Coinmerce's crypto exchange.
is a very popular decentralized exchange (DEX) and automated market maker (AMM) that allows users to trade almost all ERC20 tokens without an intermediary. Liquidity providers must deploy both sides of the liquidity pool in a 50/50 ratio, and in return earn a portion of the transaction fee and the UNI token. Want to buy Uniswap (UNI)? You can do so on Coinmerce's crypto exchange.
Balancer is a liquidity protocol that offers flexible staking. It does not require lenders to add liquidity to both pools equally. Instead, liquidity providers can create customized liquidity pools with different tokens.
is a derivatives liquidity protocol that allows users to create synthetic coins and tokens using oracles for almost any traditional financial product. This means that the prices of stocks, for example, can also be added. Do you want to buy the token of Synthetix (SNX)? You can do so on the Coinmerce crypto exchange.
is an automated decentralized aggregation protocol that allows users to use different lending protocols such as Aave and Compound to get the best returns. Yearn.finance algorithmically searches for the most profitable yield farming services. Yearn.finance's token has gained a lot of value in recent years, so it has also gained a lot of notoriety. Would you like to buy the token of Yearn.finance (YFI)? You can do so on Coinmerce's crypto exchange.
PanCakeSwap is a DEX of Binance that offers yield farming services, among other things. It has gained a lot of notoriety thanks to the Binance Smart Chain (BSC).
is a decentralized exchange (DEX) and automated market maker (AMM) launched in 2020 from a fork of Uniswap. It quickly gained popularity and is currently very popular, as newer tokens can be found on it faster than on, say, Uniswap. Want to buy the token of SushiSwap (SUSHI)? You can do so on the Coinmerce crypto exchange.
The risks of yield farming
If you want to make money, yield farming seems to be a great method to do so. Yet yield farming can be incredibly complex and carries significant financial risks for both borrowers and lenders. It is usually subject to high Ethereum
gas costs and is only worthwhile if thousands of dollars of capital is provided. Users also face additional risks from temporary losses and price fluctuations when markets are volatile.
On top of that, yield farming is susceptible to hacks and fraud due to potential vulnerabilities in the protocols' smart contracts. These coding errors can occur due to the fierce competition between protocols, where time is of the essence and new contracts and features are often unchecked or even copied from predecessors or competitors.
Yam protocol and Harvest.Finance
Examples of vulnerabilities that have led to serious financial losses include the Yam protocol (which raised more than $400 million in a few days before a critical bug was found) and Harvest.Finance, which lost more than $20 million in a hack in October 2020. There is also an increase in risky protocols these days that issue so-called meme tokens with names that can be quickly hyped. These offer returns that are so high that many users cannot ignore them.
Nevertheless, caution should be taken with these protocols, as their code is largely unverified, and the returns are subject to sudden liquidation risks due to price volatility.
The DeFi-world is growing every day. New projects are constantly emerging, increasing the competition between them. However, these projects often always have one thing in common: they need liquidity to exist.
Through yield farming, these projects can obtain the necessary liquidity. Users (farmers) can lend crypto coins and tokens that they do not need immediately to the platform. Others, the borrowers, can then borrow these tokens and coins. For this they pay transaction fees and interest.
When a user lends tokens and coins, they receive a fee for this. This is often paid out in the form of the platform's governance token. Yield farming can therefore be an attractive way to make money with coins and tokens that you are not going to use in the short term. However, there are also many risks associated with yield farming, and it is therefore not without risk. Always keep this in mind and do proper research before you lend your crypto coins and tokens to others.