7 min read
What is cryptocurrency Yield Farming and what is it for?
After having talked about what decentralized finance is, what are the main DeFi platforms and what are the DeFi use cases it is time to analyze what is cryptocurrency Yield Farming and what is it for.
When we talk about Yield Farming (or yield farming) in the crypto universe, we are not only talking about one of the latest trends in the field of decentralized finance but also about a process that allows users to automatically search for the best return on investment among the various DeFi platforms and get a return on invested capital.
Put another way, cryptocurrency Yield Farming, also known as liquidity mining, is the practice of betting cryptocurrencies with the expectation of higher rewards by moving assets within DeFi platforms in search of the group that offers the highest return.
So the cryptocurrency, instead of staying locked in an exchange or wallet, is lent through DeFi protocols and made through the Ethereum network, in order to earn a return.
This is a strategy similar to stacking, as funds are locked in a cryptocurrency wallet to enable a transaction on a blockchain network. A digital asset held in a wallet can generate funds and these funds can be staked in a pool of liquidity that are held by liquidity providers.
Investors receive interest for lending their tokens.
History of Yield Farming
The Yield Farming story begins in early summer 2020, when the COMPOUND and Aave platforms first introduced this service into the DeFi ecosystem.
COMPOUND’s strategy was to offer users a small portion of transaction fees as a reward for contributing liquidity to Uniswap or Balancer applications. Both services proved to be a huge success and many, many other platforms entered the market and started rewarding users with native tokens instead of ETH. This made Yield Farming become one of the most popular trends in the DeFi industry.
How does Yield Farming work?
Yield Farming works through liquidity providers (LP) that add funds to liquidity pools.
In exchange for providing liquidity to the pool, liquidity providers get a reward in the form of commissions generated by the underlying DeFi platform.
Yield Farming Typologies
There are several types of Yield Farming that differ in the type of risk:
- The ‘normal‘ rate consisting of the collection of commissions that provide liquidity;
- The speculative (high risk) based on “Leverage”, a process by which the borrowed liquidity is used as collateral to generate very high APY (Annual Percentage Yield). In this typology tokens are moved from one platform to another to receive, in addition to commissions, also newly minted tokens.
Advantages of cryptocurrency yield farming
Yield Farming attempts to solve some major problems affecting the finance and cryptocurrency market today. Primarily, Yield Farming offers new users of the crypto world an easier alternative to earn passive income and represents a safer alternative to cryptocurrency trading for those users who are inexperienced.
The other advantages of Yield Farming are as follows:
- They offer new strategies for cryptocurrency holders to earn returns at least a hundred times higher than what a traditional bank would offer.
- It offers higher returns than any other traditional investment channel.
Yield farmers accelerate their profits with liquidity extraction as they get tokens as a reward for lending funds, as well as high interest on their loan.
Disadvantages of cryptocurrency yield farming
- Coding risks are one of the major disadvantages of Yield Farming. In fact, incorrect and faulty coding can cause major vulnerability issues to hacker attacks, causing major problems for a platform and its investors.
- Another issue that carries major concerns is the highly volatile nature of DeFi tokens. Most investments in this sector are purely speculative and carry higher risks for the platforms.
Platforms for Yield Farming
As we have already mentioned, in Yield Farming the search for the best performance is done in the most known protocols such as Compound, Uniswap, Curve Finance, MakerDAO, AAVE, Synthetix (SNX), Balancer.
There are several DeFi projects currently involved in Yield Farming.
Below I will tell you about the most used platforms to take advantage of this tool.
AAVE: is a platform that allows users to lend and borrow a number of cryptocurrencies. It is the largest project in terms of value locked in smart contracts.
Compound: is a decentralized blockchain-based protocol that allows its users to lend and borrow cryptocurrencies. Its token “COMP” has a supply of 10 million.
Uniswap: is a decentralized exchange protocol built on Ethereum for automated liquidity provision. Its native token is “UNI,” and it has a supply of 1 billion.
Curve Finance: is a decentralized exchange designed specifically for exchanging stablecoins with low fees and slippage.
MakerDAO: is a platform that, through the Maker Protocol, allows users to take loans using as collateral a wide variety of cryptocurrencies deposited in smart contracts.
Yearn.finance: It is one of the main platforms used by Yield Farming. Its goal is to move users’ funds between different lending and liquidity protocols (Compound, Aave) to obtain the best interest rates. Yearn.finance’s native token is YFI and has a supply of 30,000.
Synthetix (SNX): is a token exchange platform that enables the creation of new crypto assets that mimic both real-world assets (such as the US dollar ) and crypto assets (such as Bitcoin).
Balancer: A second-layer platform built on top of Uniswap that allows users to earn fees by contributing to the platform by providing liquidity using multiple tokens.