What is Yield Farming?

Yield farming is a niche in the world cryptocurrency which promises insanely high profit returns. It has drawn so much attention to decentralized finance with many trying to understand what is it. I will do my best to capture this in concept in few words. So, what is yield farming?

Yield farming is generally that practice where tokens owners lend or borrow tokens to liquidity pools with the sole purpose of generating a compounded interest on those tokens and possibly other tokens depending on the protocol[1]. These interests are accrued from the transaction fees of the protocols. Yield farmers use liquidity mining and leverage to max their returns. While Liquidity mining is the practice of offering tokens as rewards from DeFi protocols to investors for lending and borrowing actions, leverage enables investors borrow and invest in other protocols.

Brief History of Yield Farming

Yield farming as a concept is not entirely a new concept as it is practiced in traditional financial system. You are aware of the concept of earning interest on your principal sum when you save up money in your traditional bank account and it accrues interests. Also, there are scenarios where investors borrow funds from one bank and invests in other sector, say stocks or another asset and later pays the initial debt from the profit realized on the other asset. This concept has been adopted and is valid in the cryptocurrency industry. There are still uncertainties as to when this practice of Yield farming began but surely Ethereum ushered the era of programmable blockchains and gave rise to the several possibilities including Yield farming a niche of Decentralised finance. A number of protocols have existed each adopting different strategies. Yield farming was started as a way of generating passive income instead of letting tokens remain passive in holders’ wallets.

In 2018 Fcoin rewarded its users with tokens for trading, this drew a massive adoption and led t some users designing bots to trade with themselves. That was the arguably the beginning of Liquidity mining. In the year following, 2019, Synthetix offered its SNX tokens to users who supply liquidity to its Uniswap sETH/ETH pool. The resulting effect was a massive sETH/ETH pool. After Synthetix, Compound was launched and offered its governance token as incentive to its users. This led to lending and borrowing BAT tokens in order to mine the Compound token. [2]

Why yield farming is an attractive proposition for users today?

Yield farming is highly risky venture which carries an appeal of high returns. Some factors make it standout.

1. It doesn’t require investors to lock in their funds unlike staking. The yield farmer is able to lend from one protocol at a low rate and supply the borrowed money to another protocol to with high returns. The generated returns are then used to pay payback the debt and usually leaving the investor with high profits. [3]
2. Farmers who adopt a new project early tends to reap high rewards with an APY ranging from 1% -1000%.
3. It allows users to earn more cryptocurrency coins making it an inexpensive form of mining cryptocurrencies.
4. It requires minimal investment to begin farming. This makes it easier and appealing for low investors.
5. A good investment strategy will surely bring more yields especially staking on Stable coins. Due to their pegging an investor doesn’t have to worry about the volatility of the markets and yet rakes in good returns.

Top 20 Most Popular Yield Farming Daps / Platforms

Here are top Yield farming platforms based on their total value locked [4] at the time of this writing.

1. Maker
2. Curve Finance
3. Convex Finance
4. Aave
5. Compound
6. InstaDapp
7. Yearn.finance
8. Balancer
9. SushiSwap
10. Liquity
11. Alpha Homora
12. C.R.E.A.M Finance
13. Alchemix
14. DeFi Saver
15. Notional
16. TrueFi
17. Synthetix
18. Harest Finance
19. B.Protocol
20. Reflexer

How To Start Farming (A Brief Users Guide)?

Farming yields is quite easy to begin. There are several platforms where yield farming is possible, however, their processes may differ. For illustration purposes, the steps outlined are from Maker’s Oasis platform [5]

1. Step 1
1. Go to the platform you are interested in to farm
2. find the page where the different pools are listed. The accompanying yield percentages will be listed by them.
2. Step 2
1. You will be prompted to connect your cryptocurrency wallet
2. Enter the number of coins you want to add, and click on the deposit option.
3. Approve the transaction from your wallet.
4. Click on Confirm Make sure to approve the transaction from your cryptocurrency wallet.
3. Step 3
1. Add liquidity to the liquidity pool you are interested in and approve the transaction directly on the platform.

Criticisms of Yield Farming

Yield farming is faced by number of criticisms:

1. The volatility of cryptocurrency assets makes yield farming experience lot of price movement in a short period of time. This can eventually lead to the liquidation of an investment. This makes that that to enjoy yield farming one must have high collaterization to withstand the volatility of the market. [6]
2. Yield farming is highly susceptible to many frauds and rug pulls. Frauds usually arise from misappropriation of accounts, where as in rug pulls, the developer or team gathers the investors’ funds, then abandons the project without returning funds.[7]
3. Lending and borrowing protocols are built on Smart contracts and smart contracts are not infallible and will have bugs and other vulnerabilities which can be exploited putting investments at risk. This is worsened by the presence of lots of low budget yield farming protocols which cannot afford contracts auditing.
4. Impermanent losses can happen on tokens when the value of staked cryptocurrency rise or fall, creating temporarily unrealized gains or losses. These gains or losses become permanent on withdrawal. This brings an argument that it is better to trade the tokens than participate in yield farming. [7]
5. Yield farming protocols are not regulated. This raises questions if these protocols are abiding by securities laws. The coming of regulators will pose risks of loss of value of tokens. [8,9]
6. Another criticism is the need of experience to be a yield farmer as many of the yield farming strategies are complex processes for inexperienced users.
7. Farming is suitable for investors with larger sums. This is due to the high cost of gas fees when transacting across different protocols on the Ethereum network. This makes it unprofitable for smaller investors.

Future Of Farming

Farming is an innovative and creative niche in the crypto space, nevertheless it has lot of risks accompanying it-a reason why many are quite skeptical about it. It requires lots of caution for an investor especially when using leverage. it’s clear that yield farming is still a nascent niche which has come to stay but its current model doesn’t look sustainable [10]. In the coming years, with regulators on the horizon, this niche may see some evolution and farming may take up a whole different outlook - yielding lower profits but become sustainable.

REFERENCES:

1. Definitive Guide to DeFi Yield Farming for Beginners - Zipmex
2. What Is Yield Farming? The Rocket Fuel of DeFi, Explained
3. Whats yield farming and how do you grow crypto?
4. DeFi Pulse - The Decentralized Finance Leaderboard | Stats, Charts and Guides | DeFi Pulse
5. Oasis
6. Learn By Bit
7. Definitive Guide to DeFi Yield Farming for Beginners - Zipmex
8. Harter Secrest and Emery LLP Attorneys and Counselors, Roch
9. A yield farming overview
10. Bitcoin News- First for SEC: Crypto Lending Platform Charged — Blockfi Agrees to Pay $100 Million in Penalties
11. What is Yield Farming? Beginner's Guide

Author: Altal

For the original version of this article, please, refer to: SVET Platform

Image: SVET is Light, by Svet and Victor

Date: 21 February, 2022