When it comes to earning passive income in the Cryptocurrency industry, there are several options. Yield farming has become one of the most popular ways for dealing with cryptocurrencies.
What is Yield Farming?
Yield farming is a commonly used investment method in Decentralized Finance ( DeFi). It is the practice of lending your crypto to get rewards in the form of transaction fees or interest. It involves moving your cryptocurrency across different exchanges to maximize returns.
Yield farming has an element where the strategy becomes less effective when more people know about it. But it is currently the biggest growth driver of the Decentralized Finance (DeFi) sector, helping it to skyrocket in 2020.
The sudden practice in yield farming can be attributed to the launch of the COMP token, a governance token of the compound finance ecosystem. Holders of governance tokens can participate in the governance of a DeFi protocol.
How does Yield Farming Work?
Yield farming is closely related to a model called automated market maker (AMM). It typically involves liquidity providers (LPs) and liquidity pools.
Yield farming protocols incentivize liquidity providers( investors) to stake or lock up their crypto assets in a smart contract-based liquidity pool and get rewards like a percentage of transaction fees, interest from lenders, or governance tokens.The rules of distribution will all depend on the unique implementation of the protocol. In the end, liquidity providers are compensated based on the quantity of liquidity they offer to the pool.
- The estimated return in the yield farming process is calculated in terms of annual percentage yield (APY).
- APY is the rate of return that the user gains over a year on a specific investment. Compound interest is also factored in the APY calculations.
- Since the DeFi summer of 2020, yield farmers have been chasing eye-opening thousand percent APYs. However, these protocols and coins may be highly risky and susceptible to rug pulls.
The Best Yield Farming Protocols
To optimize the returns on their staked funds, yield farmers will frequently use different DeFi platforms. These platforms provide a variety of incentivized lending and liquidity pool borrowing options.
Below are some of the most popular yield farming protocols;
- Aave: This is a cryptocurrency-based lending protocol that allows users to earn interest on deposits and borrow assets. Users can deposit stablecoins into Aave and collect yields ranging from 4.78% up to 13.49%, which can be added to their current earnings in the form of staked AAVE. The DeFi lending pool is open-source and enables customization for developers.
- Instadapp: This is the world’s most advanced platform for leveraging DeFi’s potential. Users can manage and grow their DeFi portfolios, while developers can use their platform to create DeFi infrastructure. Over $9.4 billion has been invested in instadapp as of August 2021.
- Uniswap: This is one of the largest decentralized cryptocurrency exchanges and DeFi platforms, with liquidity pools that allow users to earn interest on their crypto assets. It’s built on Ethereum and allows users to trade ERC-20 tokens. Because it is Ethereum-based, its gas fees can be expensive, but it does not require any identity verification or sign-ups to use the application.
- Sushiswap: This is a fork of uniswap that caused a huge wave on the community during their liquidity move. Sushiswap is now a DeFi ecosystem that allows users to trade cryptocurrency tokens through a multi-chain automated market maker (AMM) model. Liquidity providers are given sushiswap liquidity pool tokens. Other sushi-based incentives include swapping, liquidity pools, staking, and so on.
- PancakeSwap: This is a decentralized exchange launched in 2020 and is built on the Binance Smart Chain. PancakeSwap has several yield farms, each of which requires you to stake two tokens in order to receive LP tokens for that farm.
Through the LP tokens you collect from depositing tokens into your liquidity pool, you can earn rewards in the form of CAKE tokens.
The Risks of Yield Farming
- Yield farming is a complex process that exposes both borrowers and lenders to great financial risk. It is frequently prone to high Ethereum gas fees and is only profitable if thousands of dollars in capital are provided. When markets are volatile, users face an increased risk of impamarnet loss and price slippage.
- Due to possible shortcomings in the protocol’s smart contracts, it is also vulnerable to hacking and fraud. This might happen as a result of intense protocol competition, in which new contracts and features are frequently unaudited or copied from competitors or predecessors.
Investing in yield farming is highly dependent on what you are looking for regarding cryptocurrency investment.
However, if you have some tokens, you can put them to work and let them earn annual income for you rather than keeping them in your wallet.
Yield farming is a high-risk, high-reward investment with the potential for high returns, but note that it has risks.
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