Yield farming is a new way to earn crypto with minimal investments. It doesn’t require a powerful computer. It won’t increase your power bill. However, it is still a risky option to earn money that may not suit everyone.
Some said it’s too complicated a technology, while I said it’s pretty accessible for many people. However, you should stick to multiple safety rules to ease your investment career. That's why I created this article for you! Here you will find how to use DeFi farming tools in the safest possible way.
If you are interested in other alternative crypto farming options, share this article with your friends, so I’ll see that you want more articles like this! Implement best practices to build your wealth with Defiway!
The Evolution of Yield Farming
It is a DeFi practice where users lock up their crypto holdings in smart contracts to earn rewards. DeFi platforms provide compensation for liquidity provision or participation in specific activities.
Usually, they give tokens of some digital coins. DeFi farming allows users to maximize their returns by moving funds between protocols to capitalize on the highest available yields.
But with every silver lining, there is a cloud. Yield farming is a risky way to earn money. It has risks, like impermanent loss or smart contract vulnerabilities. Thus, all related parties should carefully pick the projects they participate in.
For the first few years, cryptocurrency was just an experimental field. But in 2017, we finally saw the origins of the fintech industry. Projects like MakerDAO introduced the concept of decentralized stablecoins backed by collateral.
In 2018-19 DeFi industry evolved to the point that general users witnessed the introduction of liquidity pools. Uniswap was one of the first tools providing DeFi mining.
We finally saw modern yield farming only in the middle of 2020 with the launch of the Compound Finance protocol. In June 2020, it introduced its governance token, COMP. Those who provide liquidity to the Compound get COMP tokens adding to the deposit interest.
Users saw this as an opportunity to earn without any investments. Thus, it raised a massive demand and trend among other DeFi applications. In late 2020 multiple DeFi services launched their distributing governance tokens to incentivize liquidity providers and attract users to their platforms.
They automatically manage users' funds, allocating them to different liquidity pools or yield opportunities to maximize returns. Users didn’t have to manually move their funds, which made this technology even more popular. But it also raised multiple concerns, including safety and regulation.
Understanding Yield Farming
It is a process of earning compensation by providing liquidity to DeFi platforms.
With yield farming, you can start building wealth even when you have a low income. There are a few key terms that you should keep in mind:
- Liquidity providers (LPs). They are users providing liquidity to DeFi services. Those people are the ones who earn the compensation for providing liquidity.
- Automated market makers (AMMs). Its services use liquidity pools to support trading.
- LP tokens. Its tokens represent the miner’s share of a liquidity pool.
You can farm by lending them to other users, depositing tokens into liquidity pools, or staking to participate in network consensus. It depends on the service and its features.
When you provide a DeFi platform liquidity, you become a market maker. In return, you will earn fees on the executed trades.
Despite yield farming involving minimal investments, it’s still a risky activity. There are multiple risks to consider:
- Impermanent loss and market risk. Crypto is a volatile asset that constantly changes its price. So, your tokens can lose their value when you provide liquidity to a pool.
- Smart contract risk. They are self-executed contracts that govern the DeFi services. It’s still not a perfect technology. So those contracts can be hacked or exploited.
However, it’s a great way to earn money. There are many services to choose from depending on your risk tolerance.
Getting Started with Yield Farming
To begin your journey in this activity, you should invest in this career by fitting within these requirements:
- Get a separate wallet. Your current wallet should support the tokens you wish to stack. Common options are Defiway, Binance, Trust Wallet, and Ledger Nano.
- Pick cryptocurrencies. Decide which cryptocurrencies you want to use for providing liquidity. Most DeFi farming protocols run tokens such as ETH, USDC, DAI, or other ERC-20 tokens.
- Get basic DeFi knowledge. You need to understand the general rules of this industry so no one scam you in the future. You should know how DeFi works, including the risks and rewards associated with yield farming.
- Be prepared for gas fees. Yield farming on Ethereum can be costly due to gas fees. Ensure you have enough money to cover them.
- Сhoose a DeFi platform that aligns with your goals. You can try Uniswap, SushiSwap, Aave, and Compound. Pick a platform that provides frequent security audits, and has sufficient liquidity and trading volume. Examine the tokenomics of the platform’s governance, if possible.
- Connect your wallet to a chosen service. I encourage you to use a separate wallet for farming. Don’t use your main wallet since you are putting your tokens at risk. Add funds to this separate wallet and ensure you have enough money to cover gas fees.
- Pick a liquidity pool on the DeFi platform. They consist of token pairs, such as ETH/USDC or DAI/USDT. Enter the amount of each token you want to provide to the pool.
- Receive tokens. The platform will calculate the corresponding share you receive in the pool. After providing liquidity, you'll get LP tokens representing your share of ownership in the pool and show that you can withdraw your funds later.
Be aware of the impermanent loss, which can impact your overall yield farming profitability. It happens when the value of the tokens in the pool changes compared to holding them outside it. Some victims of impermanent loss may blame a DeFi protocol, while in reality, no one steals anything. It’s just a result of crypto volatility.
Risks and Rewards of Yield Farming
Each yield miner could get attractive compensation. The sources of potential returns are next:
- Token Rewards. By providing liquidity, farmers can earn tokens as rewards.
- Fees Liquidity. Yield farmers can earn a share of the trading fees generated by the platform. The more trading activity the service has, the higher the potential earning.
- Interest rate. In some protocols, LPs can earn additional interest on their deposits. The other person borrows their money and returns them with interest.
However, DeFi farming is a risky activity. Impermanent loss is the most common danger. It happens due to price fluctuation, so when recalculating it to fiat, you may find out that you lost some money. You can't avoid it. However, you can mitigate this risk by choosing coins with relatively stable prices.
The other common risk is contract vulnerabilities. Hackers can exploit contract bugs to steal your funds from a wallet. Thus, I highly recommend you use only services that care about their safety.
Unfortunately, DeFi space is not immune to scams, malicious projects, and rug-pull schemes. Invest only the amount of money you are not afraid to lose. It’s better to be safe than sorry.
And remember about diversification! Don’t put all eggs in a single basket. Have a clear exit strategy to withdraw funds if necessary.
Case Studies Examples of Yield Farming
Some may think that yield farming is still a new unexplored concept, but I’m ready to prove you wrong. This way to build wealth has been common for the past several years.
One of the earliest examples is a SushiSwap launched in mid-2020. Service rewards them with SUSHI, its governance token.
Another example is the AAVE service. Its decentralized lending allows farmers to earn interest from borrowers. AAVE attracts yield farmers by providing competitive interest rates on deposit assets. Also, they provide AAVE tokens to farmers to give them additional incentives and give them more community engagement.
Compound Finance has decided to follow AAVE steps and introduce its lending protocol allowing users to supply and borrow. Lenders get their part of the interest and COMP governance token to boost the service liquidity.
QuickSwap is an exchange built on the Polygon (formerly Matic). It supports ERC-20 tokens and other popular cryptocurrencies. You’ll get compensation in the form of QUICK tokens.
And it’s just a small part of services that support yield farming. And as you saw, you can earn money in three ways: liquidity mining, lending, and staking. Maybe, in a few years, someone will come up with an additional way to earn money, but as of 2023, it’s the three main options of yield farming.
Future Trends in Yield Farming
This technology is rapidly evolving, and it will continue this trend in the future. We will see even more yield services: some platforms will become more niche-oriented, while Others implement cross-chain farming by using bridge solutions and additional blockchains.
We will also see more dynamic vaults. Automated farming platforms like Yearn.finance are becoming even more sophisticated, offering strategies that adapt to constantly changing market conditions. So we will see even more automated tools.
Also, it will be a glory time for Layer 2 solutions. Yield farming services often use them, so Layer 2 will become more prevalent as users seek alternatives to lower gas fees on Ethereum.
However, it will also be a time of regulatory changes. As DeFi investment opportunities become more common, we will see a rising regulatory body interest in those services. Projects will navigate compliance requirements while trying to stay true to the decentralized nature.
Yield farming may find its way into traditional finance through DeFi protocols and platforms bridging the gap between the two systems. This bold decision introduced new participants and liquidity into the yield farming space.
Yield farming is a great way to start your mining or investor career. However, it can be pretty risky. Consider this way of building capital if you are not afraid to lose some money.
Crypto is a volatile asset that can lose its value while you stack or lend coins to earn interest. You can’t withdraw money early in most of the services. Smart contracts also have volatiles, so some of them can be hacked.
That’s why I encourage you to use secure services and diversify your investments. For instance, you can run your Ethereum or Polygon wallets on Defiway and Bitcoin wallet on Finance and connect them to various DeFi platforms that allow yield farming. It can be any combination, just make sure that you don’t put all your eggs in one basket!
If you don’t want to risk coin volatility, you can use Defiway’s Bridge to exchange your favorite digital coin for some stablecoin that you can put on yield farming DeFi service.
Want to find more ways to earn money in the decentralized world? Stay with Defiway! We will have a deep dive into token farms, traditional mining in 2023, and other interesting ways to build your wealth. Stay creative. Stay with Defiway!