The rise of decentralized finance (DeFi) has opened a floodgate of investment opportunities. People can invest their funds through different products on DeFi protocols to earn decent passive income. One of the famous DeFi products is Yield Farming. So, what is Yield farming? How can you earn from it? What are its pros and cons? What does a good Yield Farming Platform look like? This article will answer all these questions in simple English.
What is Yield Farming?
Before we define Yield firming, let us first refresh our memory of how the conventional bank works. One way of earning passive income with a bank is depositing your funds in a banking plan that earns interest. The process is simple; you lend your money to the bank for a specific period with an agreement that you will receive interest. The bank invests the money to earn profits that will cover your interest, and reward the bank too with some surplus funds. As investors, you can summarize the whole process as ‘using your funds to earn more funds without involving in a real business.’
Yield farming follows a similar principle, in that it is a way of generating more funds with your funds, by simply lending it to someone. However, there are a few yet significant differences between Yield farming and the conventional bank loaning system. First, in a bank, you lend your money to a centralized authority, the bank, determines the interest and other terms of the contract. Yield farming deals with DeFi, and the terms of the contract are determined and executed by a smart contract. Second, banks deal with fiat currencies, while in yield farming, investors lock digital assets.
In brief, yield farming or yield staking is locking cryptocurrencies in a DeFi application (yield farming pools) as collateral, and earning fixed or variable interest against it. The return is in annual percentage yield (APY).
How can you earn from it?
Earning from yield farming is a simple process. You only need to find a DeFi protocol and have some funds to lock in it before you begin earning. There are many DeFi protocols, including the leading ones such as Aave, Compound, Curve Finance, MakerDAO, Uniswap, and Instadapp. Different yield farming pools may have different terms including the interest rates. Most pools protocols will only allow depositing of the native tokens into the yield farming pools. The reward can be issued in governance tokens, app transaction fees, and other types of digital funds.
Pros of Yield Farming
Yield farming has many advantages to users.
Yield farming allows users to earn more crypto with their cryptocurrency without much effort. By simply locking your funds into these autonomous pools, you begin earning interest. This model is different from crypto trading that requires analysis of the market to make the right moves that will earn you profits.
Yield farming offers highly attractive returns on crypto investment. The interest could be up to a hundredfold higher than that of traditional investment channels such as real estate, stocks, and bonds.
Users may receive their farming reward in governance coins, which gives them the privilege to take part in the decision-making on issues regarding the protocol. Yield farmers can also boost their returns with liquidity mining. They can receive tokens from the companies that borrow their funds, in addition to high loan interest.
Cons of Yield Farming
Despite promising high returns, yield farming can be a risky business. The risk can be triggered by the nature of the market and the participates.
Cryptocurrency is highly volatile, meaning you can lock your funds today, and tomorrow its value drops significantly.
You can inject your funds into fraudulent projects and schemes that steal all the farmers’ coins. Additionally, you can also be lured by rug pull protocols that collect farmers’ money and abandon the project without returning the investors’ funds.
Smart Contract risks
Smart contracts governing yield farming protocols may contain bugs or be susceptible to hacking, hence risking investors’ funds.
Some local authorities still hold tight regulations against cryptocurrency activities. The regulations pose a risk to yield farming activities, especially in countries where crypto activities are not legally acceptable.
What to look for in a Yield Farming Platform?
First, you need to consider the reputation of the platform you are using, and also if the platform has been externally audited. It is risky to blindly deposit funds into the first website you find. Reputable platforms with many users and good online reviews are safer than a website that is little known. You can also compare the interest rates of different platforms and go for the one that offers the best reasonable interest. However, you should not overlook security and other risk factors while going for a platform that promises higher returns. As usual, do your own research and don’t take this article as financial advice. Finally, consider the ease of use of the platform. A platform is only as good as you can use it. Some other examples of yield farming platforms are pancakeswap and sushiswap, some exchanges are also starting to add yield farming.