Jan 11, 2022
What is Yield Farming?
Is Yield Farming a Profitable Investment For You?
If you are conversant with the crypto space, you must have heard "yield farming" flying around your WhatsApp status, Twitter and other social media platforms.
Even if you are not conversant with the crypto space, by the end of this article, you will understand what yield farming is, the risks involved and how you can make money from it.
Ladies and gentlemen, shall we begin?
The Concept of Yield Farming.
Yield means the return you get for investing, while Farming means the exponential growth you could see for finding the right place for investing.
Yield Farming is the process of investing your cryptocurrency in DeFi protocols to maximise the rate of return on your capital.
Imagine how our traditional farming system works; we sow a cassava stem to reap a Cassava tuber.
Some US banks offer $1 interest per year for every $1,000 you invest. Meanwhile, some established DeFi protocols advertise $3,000 interest per year for every $1,000 you invest.
4 Yield Farming Methods
There are four methods of yield farming.
1. Liquidity Provider: Imagine you have $1,000 you want to invest. You buy $500 worth of ETH and $500 value of AXS to provide liquidity on Uniswap.
Now Uniswap uses the liquidity you provided to execute trades between traders on their platform. Uniswap will reward you a percentage of the transaction fee of these traders.
Imagine this pool needs a maximum of $100,000, and you invested $1,000; that's1%. However, as long as your liquidity stays, any transaction fee earned, you have a share of 1%.
2. Borrowing & lending: Some DeFi Protocols like AAVE & Comp offer their users the opportunity to borrow and lend their crypto on their platform.
If you have ETH, you can lend the platform your ETH.
Borrowing: Imagine you have $1,500 worth of ETH, and you believe it will go up. You can lock your ETH on their platform to borrow up to $1,000 value of DAI.
They will lock your ETH as collateral pending when you pay back the $1,000 worth of DAI you borrowed, including the accrued interest.
Leveraged lending: Here, let's say you have $1,000 worth of AXS; you can lend it on the AAVE protocols and borrow $600 value of DAI. Then you lend the $600 back to the platform. Now what you have is $1,600 as the money amount of money you've currently lent the protocol. With this, you can borrow up to $400 worth of DAI and lend it back to the protocol.
Your lending has a 30% APR and your token is increasing in value.
This comes with its own risk.
3. Staking: An investor invests his cryptocurrency in a DeFi protocol to earn the network token.
Staking on a network helps validate blocks on the network. When stakes validate a block, they earn coins from the network.
For instance, to stake on Tezos(XTZ), you have to set up a node for a 6% APR. To some people, the return is not good enough compared to you going through purchasing and maintaining a node.
However, the big guys like Coinbase set up these nodes and allow their users to stake on their platform to earn tower APR.
Pancakeswap is another DeFi protocol that allows its users to stake its coin to earn $CAKE without the challenge of setting up a node.
4. Holding coins with redistribution fee: Safemoon has a 10% transaction fee. This 10% transaction fee is divided into two. 5% is being burnt to reduce the supply of Safemoon tokens. The remaining 5% is shared amongst token holders. As a Safemoon token holder, you get a share of all transactions on Safemoon when you buy and store them in your Safemoon wallet, not on a Centralized exchange.
Risks of Yield Farming.
Yield farming could double or triple your money every day, just like every other investment. The higher the risk, the higher the reward. Yield farming is not an exception. I would advise that before you invest in any DeFi protocol, you should do your own research (DYOR) and understand what could go wrong.
1. Rugpulls: I see a lot of new DeFi protocols offering 1000%+ APR. Some use it as a marketing strategy to incentivise people to hold their tokens and attract new investors. But over time, their APR reduces drastically when many investors begin to invest in their platform. It reduces to a more realistic and sustainable APR. Some offer huge APR to attract greedy investors, then rug pulls.
You should always DYOR before investing in DeFi protocols and the crypto space in general. It would help if you asked yourself these questions each time you want to invest in yield farming.
Who are the people behind this project?
Are they reliable?
Do they have a good track record?
What is new about their product in the crypto space?
PS: Some use a long locking period to commit your funds before rug pulling. Be careful!
2. Impermanent loss: This applies to liquidity providers, who buy two tokens to provide liquidity on a pool.
Impermanent loss is the temporal loss of value of your investment. You provided liquidity of $500 worth of ETH and $500 worth of AXS.
=> If ETH price gives up while AXS price goes down, you will have an impermanent loss
=> If the ETH price goes up and the AXS price stays unchanged, you will experience impermanent loss.
=> If one token goes down and the other stays unchanged, you will experience impermanent loss.
Both of them should move in the same direction each time.
To avoid impermanent loss, it is advisable to provide liquidity in stable coins, though their APR are often tiny.
How to Make Money in Yield Farming.
There are two ways you can make money on Yield Farming.
1. As an investor, if you are risk-averse, you could pick any of the established DeFi protocols like Compound, AAVE, Nexo, Uniswap, Sushiswap, Binance, Coinbase, etc. To provide liquidity and be content with whatever they offer you.
This is the list of yield farming protocols. Pick one, DYOR, before investing. https://coinmarketcap.com/yield-farming/
2. If you enjoy taking a risk and want a higher return on your investment, then newly launched DeFi protocols with high APR is your best bet.
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