DeFi yield farming is becoming one of the popular ways to earn passive income with cryptocurrencies. This article provides a beginner’s guide to the world of DeFi yield farming.
The increasing innovations in cryptocurrency have produced several new opportunities while leaving amateurs in amazement. You should know the latest terms and trends to navigate the cryptocurrency world.
Many people are unsure how cryptocurrency might provide potential opportunities for earning value with their crypto holdings.
This is where you will find the ever-increasing popularity of DeFi yield farming, which is currently creating formidable highlights.
Meanwhile, the rise of decentralized finance, or DeFi, has positive implications for yield farming in the cryptocurrency space.
Are you interested in learning about cryptocurrency’s “yield” and how to farm it?
Hold on to your seats while we walk you through the DeFi yield farming world.
What is DeFi Yield Farming?
DeFi Yield farming is the process of lending or staking cryptocurrencies on a DeFi platform for interest or prizes.
DeFi platforms are decentralized, which means they run on a blockchain network without intermediaries like banks. Users can earn incentives by lending or staking on these platforms.
Lending entails lending cryptocurrencies to other users who require them, whereas staking entails locking up cryptocurrency as collateral to secure the network and gain incentives.
Yield farmers can take part in either of these activities to earn interest or prizes in the form of the platform’s native token or other digital currencies.
How DeFi Yield Farming Works
DeFi Yield farming schemes allow users to earn incentives by locking their cryptocurrency tokens for a predetermined time.
Yield farms employ smart contracts to lock tokens and pay interest rates ranging from a few percentage points to triple digits. In many circumstances, the locked tokens are distributed to other users.
Users borrowing tokens pay interest on their crypto loans, with a portion of the proceeds going to liquidity providers.
In other circumstances, locked tokens offer the liquidity the decentralized exchange requires to support trading.
This decentralized exchange frequently employs an automated market maker, which requires locked tokens to complete buy and sell orders.
In this situation, yield farmers gain passive money from transaction fees. In addition to trading fees, users frequently receive extra liquidity incentives, such as governance and newly generated tokens.
DeFi platforms, such as Curve Finance, enable users to yield farm a variety of tokens on blockchains such as Ethereum, Bitcoin, and others.
Curve employs a unique algorithm that only moves the price when the loss is less than the profit. This allows it to generate more liquidity than a typical platform.
Let us take a look at the types of DeFi yield farming.
Types of DeFi Yield Farming
The types of DeFi yield farming include;
- Liquidity pool or LP farms
- Stake farms
- Insurance mining
Liquidity Pool or LP Farms
In the case of a liquidity pool farm, customers must deposit cryptocurrency in a smart contract that has been configured to provide a liquidity pool.
Such pools function similarly to decentralized trading pairs involving two or more cryptocurrencies.
Trading is only possible in the LP farms using the cryptocurrency provided by the liquidity providers. Decentralized finance or DeFi apps reward liquidity providers with LP tokens in exchange for their deposits.
The yield farming token could assist in recuperating the deposits underlying the liquidity pool at any given time and the additional interest in the form of trading fees.
The liquidity provider tokens are crucial because DeFi apps that run liquidity mining programs create staking interfaces for depositing the liquidity provider tokens.
As a result, you can lock in your liquidity, which will be rewarded automatically and continuously with governance tokens.
Token Farming
While some protocols use fees to incentivize liquidity providers, others add an unusual twist by offering protocol tokens.
Users can earn native tokens from Protocols such as yEarn and Compound by providing liquidity to pools. When the pool is smaller, the payout rate is higher, which attracts an increasing number of “farmers.”
Protocols such as Ampleforth and BNS Finance use liquidity pools from other platforms, such as Uniswap, to allocate prizes.
To begin farming the protocol’s tokens, users must first add a set of tokens to Uniswap pools and then stake those tokens on the platform.
Each protocol has a unique technique to reward its users. Many have a variety of use cases for their platform tokens.
Stake Farms
Stake farming is another yield-generating strategy that has caught the interest of investors. The method involves a user investing crypto assets into a smart contract coded to provide a staking pool.
However, the staking pool is not comparable to a decentralized trading pair. On the contrary, it functions more as a decentralized vault for a specific type of asset.
The stake farming technique in DeFi yield farming limits trading flexibility and concentrates on deposit security. Stake farms, as opposed to liquidity pool farms, may provide users with a more streamlined experience.
In contrast to operating as a liquidity provider on a decentralized exchange, stake farms need users to deposit only one asset in order to generate passive revenue. They then focus on staking the liquidity provider coins.
Insurance Mining
Insurance mining focuses solely on yield farms, rewarding users who must deposit assets in decentralized insurance funds.
Decentralized insurance funds are extremely hazardous since successful insurance claims will be withdrawn.
Depositors in this form of yield generation could benefit from yielding farming rates on the capital they put on the line to safeguard projects.
The liquidity stability pool provides a clear example of such a system. The LUSD stablecoin would then be supplied into the pool as the backdrop for the liquidity lending mechanism.
Users earn yield farming prizes through Liquity’s native cryptocurrency, LQTY.
Moving forward, we will discuss how DeFi yield farming returns are calculated.
How DeFi Yield Farming Returns is Calculated
Farming returns are often estimated using an annualized formula. This calculates the returns you could expect over a year.
Annual percentage rate (APR) and annual percentage yield (APY) are widely used.
The distinction is because APR does not account for the effect of compounding, but APY does. Compounding, in this situation, refers to actively reinvesting gains to increase returns.
However, APR and APY may be used interchangeably. It’s also worth noting that these are only estimates and assumptions. Even short-term gains are difficult to predict precisely.
Why? Yield farming is a highly competitive and fast-paced business where rewards fluctuate dramatically.
If a DeFi yield farming approach works for a while, many farmers will take advantage of it, and it may no longer offer significant yields.
With that knowledge, we will delve into some DeFi yield farming platforms you can use to earn passive income.
Top DeFi Yield Farming Platforms
The best DeFi yield farming platforms are;
- Curve finance
- MakerDAO
- Compound Finance
- UniSwap
- Aave
- Year.Finance
Curve Finance
Curve Finance is a decentralized exchange that allows you to shift stable currency efficiently.
Users can swap stablecoins in large volumes on the Curve with little slippage. Users can add stablecoins to Curve Pools and begin earning rewards from them.
MakerDAO
MakerDao is a credit platform letting users generate DAI, a stablecoin algorithmically tied to USD, in a decentralized manner by locking their assets, such as ETH, BAT, USDC, or WBTC, as collateral.
DAI is generated as a debt against the locked collateral. Yield growers can use Maker to generate DAI for use in yield farming tactics.
Compound Finance
Compound allows people to lend and borrow assets. It’s an algorithmic money market. Users can contribute ETH and ERC20 assets to
Compound’s liquidity pool and earn incentives that continue to compound. The property was one of the first sites to implement Yield Farming.
UniSwap
Uniswap is a decentralized exchange (DEX) that supports any token swap. To form a market, liquidity providers deposit the equivalent of two tokens.
Traders can then trade against the liquidity pool. Liquidity providers receive fees for trades that take place in their pool in exchange for providing liquidity.
Many platforms offer yield farming tactics that demand users to inject liquidity into pools before staking their LP tokens for yield farming.
Aave
Aave is another decentralized system for borrowing and lending coins. Interest rates are modified algorithmically based on the market conditions.
Tokens lent immediately begin generating interest.
Another feature of Aave is flash loans, which allow users to borrow any cash as long as it is returned inside the same transaction – this helps capture significant arbitrage opportunities.
Yield farmers utilize aave widely.
Yearn.Finance
Yearn.finance is a decentralized ecosystem of lending aggregators, including Aave, Compound, and others. Its goal is to optimize token lending by algorithmically identifying the most profitable loan services.
When deposited, funds are converted to yTokens, which are regularly rebalanced to maximize profits.
Yearn.finance is useful for farmers who want a process that automatically selects their optimal methods.
Final Thoughts
As we look ahead, what can we anticipate for the future of DeFi yield farming? As with any technical breakthrough, it is difficult to predict with absolute accuracy.
DeFi yield farming is anticipated to continue evolving and maturing. DeFi and yield farming are expected to become more sophisticated and valuable as the internet goes from a simple communication tool to an essential part of our daily lives.
More advanced tactics, technologies, and platforms are likely to emerge, increasing the security, efficiency, and profitability of yield farming.