Yield farming is a way to use your cryptocurrency to make more cryptocurrency. It involves you lending money to others through the magic of computer programs called smart contracts. If you still do not know what is Yield Farming, this article will help you to understand.
What is Yield Farming?
When people talk about yield farming, they talk about it in terms of Percent Annual Yield (APY). This often leads to comparisons with the interest rates you might get on a bank savings account. While bank rates are extremely low, yield farming can generate triple-digit APYs in some cases (though these returns come with considerable risk and are unlikely to last long).
Simply put, yield farming involves lending and borrowing cryptocurrency over the Ethereum network. When a loan is made using fiat currency through a bank, the amount lent is repaid along with interest. For yield farming, the concept is the same: cryptocurrencies originally sitting on exchanges or wallets are lent out via DeFi protocols (or locked in smart contracts in Ethereum terminology) for a return.
There are several ways to generate income from your crypto assets. One way is to put your tokens on the blockchain. Blockchains that use proof-of-stake systems—such as Solana (CRYPTO:SOL), Cardano (CRYPTO:ADA), and Polkadot (CRYPTO:DOT) — Reward stakeholders for confirming transactions on the blockchain. Ethereum (CRYPTO: ETH) is also moving towards a proof-of-stake system for Ethereum 2.0 and will offer rewards to those who hold their ether cryptocurrency.
The second way is to become a lender using a lending agreement. Borrowers can use lending protocols such as Compound (CRYPTO:COMP) or Aave (CRYPTO:AAVE) to lend against their crypto assets. Interest is provided to individuals who deposit funds. So, if you are a depositor, you will receive interest from the borrower.
The last way we will discuss is to become a liquidity provider on a decentralized exchange - such as Uniswap (CRYPTO:UNI) or Pancakeswap (CRYPTO:CAKE). Provide a pair of equal amounts of crypto tokens to a decentralized exchange, enabling it to be exchanged for investors who wish to exchange one cryptocurrency for another. As a liquidity provider, you will receive a portion of the fees charged by the exchange in return.
How does Yield Farming work?
The first step in yield farming involves adding funds to liquidity pools, which are essentially smart contracts that contain funds. These pools power a marketplace where users can exchange, borrow or lend tokens. Once you add funds to the pool, you are officially a liquidity provider.
Yield farmers often use decentralized exchanges (DEXs) to lend, borrow or stake coins to earn interest and speculate on price fluctuations. DeFi yield farming is facilitated by smart contracts. Smart contracts are pieces of code that automate financial agreements between two or more parties.
Types of Yield Farming:
- Liquidity provider
- Lending
- Borrowing
- Staking
I hope you will now understand what is Yield Farming and how does it work. Risk farms present a number of risks that investors should understand before getting started. Scams, hacks, and losses due to volatility are not uncommon in the DeFi yield farming space. The first step for anyone looking to use DeFi is to research the most trusted and tested platforms.
