Yield Farming Crypto Explained
Yield farming drove the decentralised finance (DeFi) explosion in 2020. Risk-tolerant investors recognised the potential of yield farming crypto and took advantage of the chance to earn "free" interest on their cryptocurrencies. However, it is not entirely free, and the gains come with significant risks depending on the project.
The strategy employs the cutting-edge technology of smart contracts and coded contracts that execute automatically on blockchains like Ethereum. Yield farming has grown in popularity as an investment strategy. It is risky, and there are still scams in the ecosystem, but the best platforms have already proven their worth.
What is yield farming crypto?
Yield farming is a system in which users deposit cryptocurrency in a pool with other cryptocurrency users to pursue investment gains, most commonly through interest earned on the pooled cryptocurrency. It is a high-risk strategy with high potential rewards.
How does yield farming work?
Yield farming crypto functions something like a savings account with a bank. It pools depositor money and gives loans while you earn interest on the money you deposited. But in a yield farm, the cryptocurrency is invested in smart contract applications rather than converted into a mortgage or a business loan.
With yield farming, users stake their money alongside other investors in the same farm, the cryptocurrency equivalent of making a deposit.
Yield farming begins with the formation of a cryptocurrency asset pool. The following steps are taken to facilitate yield farming:
A liquidity pool is established: Creating a liquidity pool is the first step in yield farming. This is based on a smart contract that makes all investing and borrowing for that specific yield farm.
Investors deposit assets: Investors can deposit currency in the liquidity pool by connecting their digital wallets. This is known as "staking". It is similar to customers depositing at a bank or investing in a mutual fund or ETF.
Smart contract allows borrowing: A smart contract can help with various processes, such as adding liquidity to a cryptocurrency exchange market or lending to others.
Reward payout: Interest, bonuses, and rewards may differ by yield farm. You could be paid regularly or on a specific future date.
How to get started with yield farming crypto?
Here are the steps to get started:
Research yield farm investments: Begin by investigating potential yield-farm investments. You can choose from various DeFi providers or centralised exchanges to gain access to yield-farming markets.
Connect your wallet or deposit funds into your account: To participate, you must have a compatible account funded with the correct currency. You must use a compatible wallet for decentralised yield farms, such as MetaMask or Coinbase Wallet. You should use an exchange to buy or transfer the desired currency into your account for yield farming.
Put your cryptocurrency at stake: Navigate to the specific yield farm to stake your funds once connected or funded. Once staked, your currency may be locked into the farm for some time.
Collect your earnings: Based on your yield farm and deposit method, you may need to return to the yield-farm website to retrieve your earnings.
Pros and cons of yield farming crypto
The possibility of earning high-interest rates online: Yield farming crypto has the potential to earn returns over 100% APY.
Smart contracts-controlled: Smart contracts eliminate the need for middlemen and allow anyone with a compatible cryptocurrency wallet to participate.
Risks of impermanent losses: Impermanent losses occur when the value of a cryptocurrency falls while it is locked in a yield farm.
Scams and fraud: Just like in other parts of the cryptocurrency ecosystem, bad actors are out to steal money through fraudulent yield farms and other schemes.
Top yield farms
- Uniswap With more than $5.5 billion in the platform, Uniswap is the second-largest decentralised exchange (DEX) by total value locked, behind Curve Finance. To provide the swaps, the platform offers swaps with Ethereum and thousands of ERC-20 tokens and staking in liquidity pools. Liquidity providers earn a percentage of trading fees for each swap. With a large enough deposit, they can earn a lot of money. All other DEXes, including Uniswap, have varying interest rates depending on the market and pool.
Investors should exercise caution when depositing funds into pools containing volatile cryptocurrencies because sharp price swings could result in temporary losses. Additionally, just like on all DeFi platforms, a smart contract failure could result in enormous losses. There are two primary versions of the platform, known as Uniswap V2 and V3.
- Aave Aave is the current DeFi king, with a startling $10 billion-plus in total value locked. It is a decentralised cryptocurrency lending and borrowing platform that runs on Ethereum (and the Polygon sidechain). Aave's borrow APRs are some of the best available because investors have deposited so much cryptocurrency there to earn interest.
The main risk of depositing into Aave is the unlikely possibility of smart contract failure. Borrowers must consider the risk of liquidation when the ratio of the value of borrowed assets to the value of the loan's collateral exceeds a threshold (known as the maximum loan-to-value ratio), which varies by the token. Anyone can purchase your collateral, and you can only recover up to half of the loan's value.
- PancakeSwap PancakeSwap is a decentralised exchange similar to Uniswap (DEX). It works similarly to Uniswap, but runs on BSC (the Binance Smart Chain network) rather than Ethereum. It also has a few more gamification-focused features. It has by far the highest total value locked of any BSC DeFi project, at around $7 billion. PancakeSwap provides BSC token swaps, interest-earning staking pools, a gambling game in which users predict the future price of BNB and even NFT art.
PancakeSwap carries all of the risks associated with Uniswap, including temporary loss due to smart contract failure and significant price shifts. Many tokens in PancakeSwap pools have small market capitalisations and thus face an increased risk of impermanent loss. Users of Uniswap face the same risks, but the platform offers more and more significant Ethereum-based tokens for staking.
- Curve Finance The platform's unique market-making algorithm allows it to use the locked funds more effectively than any other DeFi platform. Both swap users and liquidity providers profit from this.
With respectable APRs, Curve offers a long list of stablecoin pools pegged to fiat money (mainly the USD). Curve maintains strong APRs for liquid tokens of between 1.9% and 32%. On the condition that the tokens don't lose their peg, stablecoin pools are exceptionally secure. Impermanent loss can be entirely avoided because their prices won't vary significantly from one another. Using Curve carries the same risks as other DEXes, including impermanent loss and smart contract failure.
- Yearn Finance Yearn Finance (YFI) provides a unique yield farming and aggregation tool. Its active development team is constantly coming up with new ideas to help users achieve ever-higher yields. Additionally, Yearn and Curve Finance have a close integration. Investors can deposit one of five cryptocurrencies (ETH, DAI, WBTC, USDC, or USDT) into a smart contract that deposits into the corresponding pool on Curve to earn interest by investing in one of the platform's more than 30 Yearn-integrated Curve pools. The smart contract compounds gains by reinvesting earnings back into the pool. Yearn is subject to the same risks as other yield-farming platforms, including impermanent loss and failed smart contracts.
Is yield farming beneficial?
Yield farming is an intriguing way for cryptocurrency enthusiasts to profit from their investments and the currency's value growth. However, due to the risks involved, yield farming may not be worthwhile for many investors, especially newer investors.
It can be alluring to consider earning 100%, 200%, or even higher in annual interest. However, you shouldn't engage in yield farming unless you fully comprehend how it operates and its dangers.
Conduct due diligence on the exchanges, coins, and teams behind the yield farming engagement you intend to enter. All of these things are required to reduce the risks associated with this investment.
Author: Priya Kumari
Priya is a passionate content writer and the co-founder of Finendorse. She is an enthusiastic crypto investor and has a huge interest in the upcoming digitisation age.