By doing yield farming, you can make more money with your present bitcoin. You would lend money to other people via computer programmes called “smart contracts.” You are compensated in bitcoins for your services.
Farmers that want to boost their production will use trickier strategies. They frequently switch their cryptocurrency holdings between various lending platforms in an effort to maximise their profits. Additionally, they’ll maintain the best yield farming strategies a closely-kept secret because a technique loses effectiveness the more people who are aware of it. Farmers compete for the best crops to grow in yield farming, which is the wild west of Decentralised Finance (DeFi).
The Decentralised Finance (DeFi) movement has been at the forefront of innovation in the blockchain space. What sets DeFi applications apart from other ones? They are permissionless, allowing anybody (or anything, like a smart contract) with an Internet connection and a compatible wallet to engage with them. Additionally, they typically do not require belief in any intermediaries or custodians. They are not reliable, to put it another way. What novel uses are so enabled by these characteristics?
One of the new ideas that has emerged is yield farming. It’s a fresh way of earning rewards by keeping bitcoin and utilising permissionless liquidity protocols.
By using the Ethereum-based decentralised ecosystem of “money legos,” it enables anyone to generate passive revenue. Yield farming could therefore affect how investors hold their investments in the future. When you can use your assets effectively, why hoard them?
Consequently, how does a yield farmer tend to his or her crops? Can they expect any returns at all? If you want to become a yield farmer, where do you start? We’ll go over every one of them in this blog post.
How does yield farming work?
The practise of harvesting income from bitcoin assets is known as yield farming or liquidity mining. It means safeguarding cryptocurrency and profiting from it, to put it simply. Farming for yield and staking are related in several respects. But there’s a lot going on behind the scenes that’s quite complicated. Liquidity providers (LPs), who make financial contributions to liquidity pools, are frequently partners in this.
What does a liquidity pool mean in general? A smart contract with money, essentially. For delivering liquidity to the pool, LPs receive compensation. The fees associated with the underlying DeFi technology could serve as the source of this incentive.
Some liquidity pools offer a range of coin payouts. These reward tokens can then be added to different liquidity pools to win more rewards, and so forth. You can imagine how quickly really complex methods might change. The essential idea is that a liquidity provider contributes money to a liquidity pool in return for benefits.
ERC-20 tokens are typically used for yield farming on Ethereum, and these tokens are also used for rewards. This might alter in the future, though. Why? The Ethereum ecosystem is where the majority of this activity is presently occurring.
However, future DeFi apps might be blockchain independent thanks to advancements like cross-chain bridges. They might therefore operate on other blockchains that support smart contract capabilities. Farmers that want to produce high yields frequently switch their financial resources frequently between various methods. In order to draw more capital to their platform, DeFi platforms may therefore provide additional financial incentives. Like it does on centralised exchanges, liquidity tends to draw in more liquidity.
Yield farming methods
The numerous forms of yield farming include the ones listed below;
1.Liquidity provider: Users deposit two currencies to a DEX to provide trading liquidity. Exchanges charge a small cost to switch between the two coins; this fee is given to liquidity providers. This fee could occasionally be paid in new liquidity pool (LP) tokens.
2.Staking: There are two different kinds of stakes in the DeFi universe. Users who pledge their tokens to the network as security on proof-of-stake blockchains are compensated with interest in return. The second choice is to stake LP tokens that were gained by giving a DEX liquidity. Since users are paid in LP tokens for providing liquidity, which they can then use to invest in order to increase yield, they can earn interest twice.
3.Lending: Holders of coins or tokens can use smart contracts to lend cryptocurrency to borrowers and collect interest on the loan.
4. Borrowing: Farmers are able to borrow more tokens by pledging one token as security. The money lent can subsequently be utilised to increase agricultural output. This enables the farmer to keep their initial investment, which can increase in value over time, while also earning interest on the borrowed coins.
What is the process of yield farming?
Users who provide bitcoin to the DeFi platform’s operations are known as liquidity providers (LPs). These LPs donate money in the form of coins or tokens to a liquidity pool, a decentralised application (dApp) made of smart contracts that holds all of the money. According to the underlying DeFi platform that the liquidity pool is running on, LPs that deposit tokens into a liquidity fund are compensated with a fee or interest.
To put it simply, it’s a means for you to make money by lending your tokens to other users via a decentralised application (dApp). As a result of the usage of smart contracts, there is no middleman or intermediary in the financing process.
The liquidity pool drives a market place where anyone can lend or borrow tokens. Access to these marketplaces is subject to fees, which go towards paying liquidity providers for staking their own tokens in the pool.
The vast majority of yield farming occurs on the Ethereum platform. The rewards are therefore an ERC-20 token. While lenders are free to use the tokens anyway they see appropriate, the bulk of them are currently speculators searching for opportunities to engage in arbitrage by taking advantage of fluctuations in the token’s market price.
What are the risks of yield farming?
Cyber theft and fraud are significant concerns, in addition to the regulatory risks that most digital assets face because there are no clear rules governing cryptocurrencies globally. Digital assets that are held via software are a component of every transaction. Hackers are adept at identifying flaws and opportunities in software programmes that they can use to steal money.
The issue of token volatility is another one. Prices for cryptocurrencies have a history of being unpredictable. A token’s price may fluctuate when it is locked in the liquidity pool during brief periods of volatility. You might be better off if you kept your coins open for trade as this could lead to unrealized gains or losses.
DeFi platforms’ smart contracts aren’t always as trustworthy as they seem to be. Numerous of these emerging DeFi protocols are being created by tiny teams with few resources. This increases the chance that platform-wide smart contract issues will exist.
In conclusion, yield farming has a number of risks. DApp developers, smart contracts, and market volatility pose the most frequent hazards.
DApp developers may misappropriate or waste deposited assets. The vulnerabilities or exploits in smart contracts may lock or enable the theft of money. Impermanent loss, which mostly impacts DEX liquidity pools, can be brought on by market volatility. The best method to reduce the dangers associated with yield farming is to thoroughly investigate enterprises before making any deposits and to stick with ventures that have a proven track record.