What do you mean by Yield Farming in Defi?

Yield farming is the process that uses decentralized finance to maximize returns and is a method to create more crypto with your crypto. The procedure involves lending your funds to others via the help of computer programs known as smart contracts. In return for your service, you could earn fees in crypto form. 

Yield farmers use highly complicated strategies and move their cryptos every time between varying lending marketplaces to maximize their returns. Yield farmers can be very secretive regarding better yielding farming strategies. Yield farming seems to be the wild west of decentralized finance where yield farmers compete to grab a chance to farm for better crops.

Yield farming is a process of generating rewards with cryptocurrency holdings. It means locking up cryptocurrencies and grabbing rewards. It is a type of smart contract that can include funds, and some liquidity pools might pay the rewards in various tokens. Defi platforms might offer you various other economic incentives to attract more capital to their platform.

How does yield farming work?

Yield farming is also called liquidity farming. It works by permitting an investor to stake up their coins by depositing them into a lending protocol via a decentralized application. Various other investors can borrow the coins and use them for speculation, where the investors try to profit off with sharp swings they anticipate in the coin’s market price. Yield farming, in simple terms, is only a reward program for early adopters.

Block chain-based apps offer incentives to users to offer liquidity by locking their coins in a staking procedure. Staking arises when centralized crypto platforms take over customers’ deposits and lend them to seek credit. Users, who are into yield farming, lend their funds by adding them to smart contracts. Investors who could lock up their coins on yield farming protocol can earn interest with more cryptocurrency coins. If the rates of those additional coins appreciate, investors’ returns will rise.

This procedure offers liquidity to new locked blockchain apps that can sustain long-term growth. These apps can improve community participation and secure liquidity by rewarding users with incentives like their own app transaction fees and governance tokens. Another staking for the incentive is to accumulate cryptocurrency shares to force hard work where the main infrastructural change is created.

Safety of yield farming

Yield farming comes up with various risks, and these are as follows. 

  • Volatility

It is a degree to which investment rates fluctuate and experiences massive price movement in just a short time. The rates of your tokens might crash during their lock-up.

  • Fraud

Yield farmers might accidentally take their coins into fraudulent schemes or projects that make off with every farmer’s coins. According to a report, misappropriation and fraud account for crypto crimes.

  • Rug pulls

It is an exit scam where a cryptocurrency developer gathers investors’ funds for a project and then abandons it without returning the investors’ funds. 

  • Risk of smart contract

The smart contracts used in yield farming can include bugs or be susceptible to hacking and put your cryptocurrency at risk. Most risks with yield farming are related to underlying smart contracts.

  • Impermanent loss

Your cryptocurrency value might fall or rise, creating temporarily unrealized losses or gains. These losses or gains might become permanent whenever you withdraw your coins and result in better off if you keep your coins available to trade.

  • Regulatory risks

Various regulatory questions revolve around cryptocurrency, and some securities and digital assets can fall under its jurisdiction, permitting them to regulate it.

Is yield farming profitable?

While yield farming seems risky, it can also be highly profitable. Otherwise, no one will bother to attempt it. Various apps offer yield farming rankings with varying liquidity pools daily and yearly. Many of these might also possess a high risk of impermanent loss making the investors question if the potential reward is worthy of the risk. Your entire profit will also depend on how much cryptocurrency you can stake. For achieving profitability, yield farming needs hundreds of dollars of funds with extremely complex strategies.

Yield farming protocols

Yield farmers can use Defi platforms to provide varying incentives for lending to optimize returns on stacked coins. Here are some yields farming protocols that you require to know about:-

  • Aave

It is an open-source liquidity protocol that allows users to borrow and lend crypto and earn interest on deposits. The interest is earned based on market borrowing demand, and you can act as a depositor and borrower by using deposited coins.

  • Compound

It is an open-source protocol built up for developers that can use algorithmic and autonomous interest protocol to know the rate depositors. 

End Words

Yield farming includes locking up or staking your cryptocurrency in exchange for interest or more crypto coins. As the cryptocurrency becomes more famous, yield farming will become its primary stream in the coming world. It is a simple concept that has been around for as long as banks have appeared and is a digital version of lending with interest to provide profit to investors. While it can be easy to earn huge returns with yield farming, it is also equally risky. If you want to engage in yield farming, ensure to do your research.