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Yield farming refers to depositing tokens in a digital currency participation pool in a DeFi protocol to receive rewards; which is basically paid in the protocol’s sovereign token. In fact, digital currency yield farming means lending your capital or staking it in order to receive rewards and create returns in the field of cryptocurrencies.
This method encourages people active in the cryptocurrency market to deposit their assets into the digital currency participation pool and rewards these people in return. In other words, yield farmers provide liquidity for different token pairs and receive rewards in cryptocurrencies.
Profit cultivation is a new financial incentive that enables the DeFi infrastructure to encourage liquidity and fair distribution of tokens.
One of the most common ways to harvest profits is by depositing crypto assets into a trading pool or decentralized lending in order to provide liquidity. In exchange for providing liquidity to DeFi platforms, Providers (LP) will be able to earn a certain annual percentage return (APY).
The most famous and popular DeFi protocols operate on the Ethereum network. Therefore, most yield farming platforms are enabled by ERC-20 tokens. In the continuation of this article, more about what is yield farming digital currency? I will pay
What is yield farming digital currency?
Digital Currency Yield Farming (Yield Farming) means locking capital in a decentralized financial platform called DeFi, in return for which users will be paid interest.
Yield farming is a way to earn money from digital currency. In this way, you get rewarded by depositing your tokens into a DeFi ecosystem. On the other hand, the DeFi platform can also lend digital currency to other users with your tokens or provide liquidity for a participation pool and pay your profit from activities.
Yield Farming is made possible by smart contracts in decentralized application or DeFi.
In fact, in this method, you are rewarded for holding digital currencies. In Yield Farming, instead of storing or exchanging your assets, you are able to work with them in a less risky way. When entering a Yield Farming offering, you will encounter people called Liquidity Providers (LP) in the participation or liquidity pool. People in Yield Farming contribute their assets to the digital currency participation pool and in return receive several tokens as a reward.
Then the received tokens can be re-deposited in another participation pool and get rewards again. In fact, Liquidity Providers (LP) divide their assets between different protocols to earn more rewards. Since yield farming is done by ERC-20 tokens of the Ethereum blockchain, the reward received will also be from ERC-20 tokens (this may change in the future).
How does yield farming work?
Although the method of yield farming seems simple at first glance, it has many complications. This system is generally similar to the lending system of banks.
In traditional banking, some people keep their capital in the bank to receive interest, and others take loans from banks. With the difference that banks are an intermediary in this process and receive a large part of the profit. But the basis of work in yield farming is to remove the middleman with blockchain. Therefore, in this way, as a digital currency provider, you will have more access and profit.
Another point in profit cultivation is the calculation rate of the bonus received by liquidity providers. This rate may vary based on the liquidity available in the digital currency participation pool. In other words, the bonus rate is determined based on supply and demand.
This means that if the liquidity in a participation pool decreases, the provider’s reward will increase. But you should be careful that in this case, the person providing liquidity will be more exposed to danger and risk.
Yield farming is offered in decentralized (DeFi) applications and protocols. Some of the best farming protocols such as Uniswap, Curve Finance and Aave etc. are. In cryptocurrency yield farming, there is a tight and intense competition among liquidity providers; Because the more people know about its strategies, the profit of the people present in it will decrease.
Different methods of Yield Farming
Profit cultivation has three different methods through which you can earn profit:
Money markets
Digital currency holders in the money markets method can profit from their current assets by lending their tokens on platforms such as Maker, Compound and Aave. In addition, different platforms have different return rates; For example, Aave has both variable and fixed interest rates for users. Of course, although the fixed rate is more profitable for the borrower, the lenders generally prefer the variable rate. The Compound platform also offers native COMP tokens as an incentive to borrowers and lenders.
One of the unique aspects of DeFi money markets is that the borrower’s collateral must be greater than the amount of the requested loan; This means that farmers must deposit more collateral than the requested amount of the loan on the platform so that the lender does not lose his property in case of failure to repay.
Cash pools
Liquidity Pool is a type of smart contract that allows users to receive rewards in exchange for providing liquidity; This reward is provided either through transaction fees on the DeFi platform or the fees of borrowers on lending platforms and sites. These rewards are paid at various rates and it is even possible that some tokens are paid as rewards to the liquidity providers. In most DeFi protocols, liquidity is very important; Because it allows them to provide their customers with a hassle-free experience.
From a financial point of view, it can be said that liquidity pools have better returns for users than money markets; But at the same time, they have their own risks. Liquidity providers on the Uniswap platform are encouraged to contribute an equal amount of 2 tokens to the pool using native platform tokens; In such a way that their overall ratio remains constant even if the number of people who add tokens increases.
Platforms like Curve operate with a different algorithm that offers users more attractive fee rates and less drop-off when exchanging tokens. In addition, Balancer allows users to hold multiple tokens (up to 8 numbers) at the same time by creating a set of liquidity.
motivational plans
People who are active in the field of digital currency farming will have the opportunity to receive the return of their investment in the form of incentive schemes. For example, platforms like Synthetix offer SNX tokens to users in exchange for liquidity. The Ampleforth platform also allows users to earn native AMPL tokens for their liquidity efforts.
In terms of how easy it is to do yield farming, it all comes down to one’s experience in the field of DeFi and crypto; For example, some yield farming strategies are very complex and users need to have deep and extensive knowledge of different platforms and a correct understanding of technical risks and financial risk. Therefore, users with less knowledge should use simpler methods to participate in yield farming. Currently, Yearn Finance is the most popular tool to do this.
Read more: Types of financial risk in the digital currency market and investment risk management training
Advantages and disadvantages of yield farming
Yield Farming is a suitable way to earn money from digital secrets for people who have high experience in this field of information. When you enter your assets into liquidity pools and become known as a liquidity provider, you’ve taken a big step forward. You will create bright horizons for yourself by receiving rewards and investing in digital currency twice on it.
Read more: Learning to invest in digital currency
Another important point is honesty, transparency and confidence in this concept. This system is circulating among the borrowers and providers, and no third party or system intervenes in it. In other words, there is no news of hidden fees and profits between different people.
However, you should still use your knowledge, precision and experience in entering this issue. The good reward of this method is certainly not safe. In this way, you have to consider things such as market instability, hacking, the possibility of fraud or Ponzi scheme, and risks related to smart contracts, etc. pay attention. In the following, we will discuss the advantages and disadvantages of this method:
Read more: Ponzi Schema and how to spot a Ponzi scam
Another important point is honesty, transparency and confidence in this concept. This system is circulating among the borrowers and providers, and no third party or system intervenes in it. In other words, there is no news of hidden fees and profits between different people.
However, you should still use your knowledge, precision and experience in entering this issue. The good reward of this method is certainly not safe. In this way, you have to consider things such as market instability, hacking, the possibility of fraud or Ponzi scheme, and risks related to smart contracts, etc. pay attention. In the following, we will discuss the advantages and disadvantages of this method:
Benefits of Yield Farming
- Liquidity supply: Cultivating profits will create efficient trading and reduce slippage on the DEX. By providing liquidity, users will play an important role in the functioning of the DeFi ecosystem.
- Passive income: Instead of storing assets or holding digital currency, users in Yield Farming can use their assets without trading and get rewards in the form of additional tokens and fee income.
- High efficiency: Some Defi projects offer attractive returns beyond traditional financial instruments. Depending on the market conditions, users can potentially receive significant returns on their capital.
Read more: What is digital currency holding or HODL?
Disadvantages of profit cultivation
- Fluctuation rates: Yields change based on supply and demand dynamics; This issue makes it difficult to predict potential rewards in the future. For example, if more people supply the asset, the yield can fall.
- Disadvantages of smart contract: As mentioned earlier, DeFi protocols are based on smart contracts. By exploiting any problem or vulnerability in the code, hackers can destroy the deposited funds.
- Fluctuating prices: Cryptocurrency prices can fluctuate a lot and affect the value of rewards and deposited assets. If the value of the token on which you earn rewards drops significantly, you may lose all of your profits.
- Permanent losses: Permanent losses usually occur in AMMs due to the mechanism used to maintain balanced liquidity among the participation pool tokens. If, after providing liquidity, the price of tokens in the digital currency participation pool changes significantly, the platform's automatic system is likely to balance the pool by selling more expensive tokens and buying cheaper tokens. This action can cause losses to those who do yield farming.
Yield farming is done by methods such as liquidity provision, digital currency stake, and Hi loan in DeFi platforms with the aim of receiving profit. In this method, an investor gets rewards in the form of digital currencies.
Platforms that cause yield farming are usually DeFi protocols that can be attacked by hackers if there is a system bug. However, the probability of these attacks is less in secure networks such as Ave.
