Yield Farming: What Is It?

The innovative word of crypto keeps surprising the members of its community. Not so long ago there appeared a new way to gain profit out of your investments, called “Yield farming”. In this article we will find out what yield farming is, how it works and is it worth investing into.

What Is Yield Farming?

Yield farming is a system in which crypto holders can deposit their funds in a pool with other users to pursue investment gains. The process itself is typically similar to depositing money to the bank although the main difference is that in a farming system your funds are locked for a period of time. The process of it is called “staking”. Users typically obtain interest out of lending their crypto. The strategy itself is very risky, but promises its participants high rewards.

The potential reward comes with big risks, as protocols and coins are extremely volatile. You shouldn’t also forget about rug pulls when projects get abandoned by their developers and leave investors without their rewards.

Yield farms could be found through DeFi platforms or cryptocurrency exchanges.

Now that we know what yield farming is, let's talk about how it works.

How Does Yield Farming Work?

An investor stakes their crypto through a ‘lending protocol’ via a dApp. Now the liquidity is in and other investors can borrow it for their own investments.

Yield farming rewards early investors and often governance tokens of that blockchain will be given out to keep them as a user, and their liquidity in the system. Users of the decentralized system are allowed to vote on any new legislature. These governance tokens given as a reward for yield farming are important as they are at the core of any DAO or project run by users.

The ecosystem is kept alive by liquidity pools as most of the early liquidity comes from the smaller projects.

Want to know how to yield farm?There is a list of steps taken at the process of yield farming:

1. Yield farming begins with the creation of a liquidity pool, the creation of which relies on a smart contract that facilitates all investing and borrowing for the specific yield farm.
2. Investors stake their funds by connecting their wallets to the pool.
3. Smart contract facilitate quite a few processes including adding liquidity for a cryptocurrency exchange market or lending to others
4. At the result participants are rewarded with interest, which may vary by yield farm. Set regular intervals or specific dates at which you want to be paid and claim your rewards at the website.

Types of Yield Farming

Liquidity provider: To provide trading liquidity users deposit two coins to exchanges. By the small fee taken by the exchange to pay liquidity providers to swap the two tokens. The fee sometimes is paid in liquidity tokens.

Lending: Holders lend crypto to borrowers through a smart contract and earn interest from the lending.

Borrowing: There is a possibility to use one token as a collateral and receive a loan from another. The farmer keeps their holding when also earning yield on their borrowed coin.

Staking: There are two forms of staking. The main one is on proof-of-stake blockchains: a user is paid interest to pledge their tokens to the network. This is made to provide security. The second option is to stake liquidity pool tokens earned from providing liquidity for exchanges. This way the supplier obtains yield twice.

What Are Rewards for Yield Farming?

Yielding starts its history in 2020 and holders were able to brag about triple-digit APY rates, which is unusual among non-crypto users. However, these rates result in extreme volatility so there are definitely risks and we'll dive deeper into it later.

Anyway yielding stays profitable, yet it depends on how much money, time and effort you will put into it. It also requires a thorough grasp of DeFi platforms and other products to be most effective.

To make passive income, better place your money into a trusted platform or liquidity pool to test it and see how it is. After developing a level of confidence, you may move to other investments.

Risks of Crypto Yield Farming

Higher risk tolerance is required if you want to operate on a purely speculative market. The other factor that brings risks is that yield farming operates on decentralized exchanges.

Rug Pulls
Rug pulls occur when developers of crypto projects abandon their projects and never return invested money to previous users. Yield farmers are at a great risk because of the nature of the projects they usually partake in.

Smart Contract Bugs or Hacks
If the bug occurs, it makes farmers vulnerable to hacks and thefts.

Impermanent loss
In theory investors may lose more than they invested as the farmer’s coin still follows the market value of that coin.

Volatility
Crypto volatility is pretty much unpredictable, it can skyrocket as well as plummet while your funds are locked in stake and you can do nothing about it.

Regulatory risk
The situation with crypto regulation is still uncertain as the SEC accuses some assets of being securities, which makes the process more complicated.

Is Yield Farming Worth It?

To do yield farming successfully, it is important to have a working strategy and be passionate about gaining an income. To better your experience it is worth learning more and firs of all looking up yield farming crypto lists or best yield farming crypto platforms. Your goal should be to chase the best yield possible. The other aspect to be aware of is that it is profitable only if you are ready to invest a considerable amount of money, otherwise your income will be eaten by gas fees. The idea of earning doubled or even tripled sums can be enticing, however, it is not a good idea if you do not understand basic algorithms of yield and be aware of possible risks.

Pros and Cons of Yield Farming

Pros

• The opportunity to earn high interest: There is an opportunity to earn over 100% APY.
• Smart contracts based: When you use smart contracts there is no need for a middleman to participate. The transaction is possible if a participant just has a compatible wallet.
• Part of a DeFi system: The opportunity to be a part of an innovative DeFi system.

Cons

• Impermanent loss risk: If the price of cryptocurrency locked will go down, your losses will be impermanent.
• Scams and hacks: It may be risky as it is for any part of the cryptocurrency ecosystem.
• Tax reporting challenges: Yield farming only adds up to the complicated nature of managing crypto transactions.

How to Start Yield Farming

These are the steps to participate in yield farming yourself:

Research yield farm investments: Firstly, research potential yield-farm investments – there are a bunch of yield farming platforms to choose from.

Connect your wallet or fund your account: To participate in yield farming make sure your wallet is compatible.

Stake your cryptocurrency: Stake your funds and get them locked for a certain amount of time.

Collect your earnings: The process of collecting rewards depends on a yield farm chosen.

Final Thoughts

It is a quite risky activity to yield crypto because that involves locking up your crypto assets to earn interest out of this. Your success in yield farming mostly depends on your risk tolerance. Those who are the most attentive to their farms are getting the most out of this and losing the least.