TL;DRYield farming is a way to put your cryptocurrency to work, earning interest on crypto.It entails lending your funds to other participants in the DeFi ecosystem and earning interest on these loans by utilizing smart contracts.Yield farmers can strategically move their assets across multiple DeFi platforms to capitalize on their cryptocurrency holdings.
What Is Yield Farming in Crypto?
Yield farming, also known as liquidity mining, refers to the lending or staking of cryptocurrency in decentralized finance (DeFi) protocols to earn additional tokens as a reward. Yield farming has become popular because it offers the potential to earn higher returns compared to traditional saving methods.
Lets say an investor owns coins like ether (ETH) or stablecoins like DAI. Instead of letting these assets sit idle in their crypto wallet, they can put their coins to work by lending or depositing them on various DeFi platforms. These DeFi platforms can be decentralized exchanges (DEX), lending and borrowing platforms, yield aggregators, liquidity protocols, or options and derivatives protocols.
In exchange for providing liquidity and becoming a liquidity provider (LP), investors may receive the platform’s native tokens, governance tokens or even a portion of the platform’s revenue in blue chip coins such as ether. Yield farmers may use a liquidity pool to earn yield and then deposit earned yield to other liquidity pools to earn rewards there, and so on. Its easy to see how complex strategies can emerge quickly. But the basic idea is that a liquidity provider deposits funds into a liquidity pool and earns rewards in return.
The estimated yield farming returns are usually calculated on an annualized basis. This is an estimate, but it’s important for investors to understand how much they can expect to pay for yield farming given the complexity of the DeFi model. The costs of yield farming vary depending on the tokens used and include the original cryptocurrency put up by a lender, interest earned, and in-house governance token rewards. While using stablecoins reduces this risk, it’s still high if the goal is maximizing gains from governance tokens.
Dedicated tools exist to work out likely costs for yield farming strategies, such as predictions exchanges that monitor changes in non-stablecoin token prices. However, there are secondary considerations like Ether gas price spikes resulting in inflated transaction fees for ERC-20 token transfers. While it’s possible to keep the risk of loss to a minimum with an attentive strategy and suitable background knowledge, investors should be aware that high-risk cryptocurrency trading strategies can result in significant losses.