Demystifying Yield Farming – The Risks Are Worth the Rewards
Over the past year, yield farming has become a common buzzword and an unstoppable force in decentralized finance.
So what exactly is yield farming? Various blockchain-based applications offer customers incentives to use or provide liquidity to their platform.
Yield farming is the intention of earning these incentives for a profit. It can be as simple as depositing funds into an app and waiting for a while to collect your rewards.
So instead of keeping ethereum stagnant in your wallet, yield farming is a way to make crypto work for you.
Encourage a collective “bank”
Decentralized applications (dApps) like an exchange are basically just computer code living on the Internet. However, they lack a core group of donors to provide liquidity like a traditional bank does.
These Decentralized Exchanges (DEX) rely on individual users like you and me to deposit funds into pools of liquidity. Through collectivization, these pooled deposits act as the “bank,” which the exchange can then use to perform automated swaps. To attract depositors, the application code has the ability to issue reward tokens as an incentive.
By providing a continuous incentive to depositors, DEXs, in turn, have a reliable source of liquidity without being dependent on a single centralized entity such as a corporation or government.
The advantage of aggregation platforms
Yield farming is diverse and depending on the platform there may be over 100 different farms to consider. For the new user, the easiest method would be to use a digital dollar like USDC, which would not be impacted by market volatility.
Using a fiat exchange, users can exchange their fiat currency for USDC. They can then withdraw the funds to a web wallet.
The user would then visit an agricultural app and deposit the USDC funds to the affected farm. Over time, your depositors’ rewards will accumulate, earning you passive income on your digital dollar.
With yield farming, instead of your cryptocurrency sitting still in a wallet and only earning on the ups and downs of the market, it is instead invested to earn you more tokens than you can invest over and over.
However, with so many options to choose from, users can easily get lost or fall for scams in such a complex ecosystem.
Aggregation platforms attempt to reduce these risks and automate the most lucrative farming strategies under one platform. Allow users to relax and let in passive income.
Automation as the best strategy
A yield farming strategy is a smart contract coded to fulfill orders in order to earn rewards for users on their crypto assets. A single asset strategy is to use a single crypto asset, like ETH, to deposit and earn a return.
More advanced strategies, like mining the Curve.Fi CRV token, require you to deposit a mix of tokens on the platform for a potentially more lucrative but riskier strategy.
There are many apps that users can take advantage of for yield farming, and each has its own rules that determine these rewards.
Farming strategies can change from day to day as new farms appear with new deposit requirements and new payout amounts. Users can get the most rewards by frequently managing their risks and strategies or by letting an automated platform manage them.
When farming, you also need to decide if you keep the reward tokens you receive, hoping that they will increase in value in the long run, or if you sell the rewards for immediate profit.
However, when visiting a particular farm, it is important to note that the rate of return is usually displayed in the form of an APY. This is a percentage based on composition.
This means reaching the high percentage displayed. You must sell the rewards and deposit the profits back into the farm.
This dialing process can be expensive and prohibitive, forcing the user to keep the rewards and earn exponentially less than the posted rate.
Using an automated platform can help solve this problem. Since user funds are collectively pooled and act as one large depositor, these previously prohibitive costs are shared among thousands of users, costing just pennies per user.
Trust the developers
Each yield farming protocol develops its own strategies to attempt to maximize yields for its users.
Often times, lead developers create and execute smart contracts that execute the strategy. At the same time, community members help find and come up with new strategies. This shows the truly collaborative nature of these decentralized organizations.
These strategies can change day to day and hour as lucrative opportunities emerge and developers act quickly to maximize returns.
Developers consider the safety, liquidity, and return within a pool when developing strategies. Choosing to use a particular yield farming protocol means trusting the developers and the community. You have to believe that they will build and execute the safest strategies for their users.
Not only do developers need to make sure their own code is safe, but any project that they plug a policy into should also be considered safe.
A comparison between risk and reward
Everyone has a starting point for learning how to use their digital assets. The main reason people don’t produce yield farming is the volatility of crypto assets, combined with high Ethereum gas fees and the bad reputation of DeFi projects resulting from hacks and scams.
A great analogy would be the American Wild West / Gold Rush. An opportunity to get rich and to be a pioneer in a new world, to claim a new future.
However, with all this potential, there was the risk of the great stranger filled with scams, thefts, and the possibility of losing everything. The same can be said about cryptocurrencies and DeFi while still in this unregulated and pioneering stage.
In my opinion, when you look at a measly 0.5% APY holding fiat in your bank account, compared to a standard 30-60% APY for putting your digital dollars in a yield farm pool, it seems almost trivial to doubt. of this powerful new way to store and earn on your digital assets.
- $ 5,000 x 64% APY (annual) = $ 8,225
- $ 5,000 x 0.5% APY (annual) = $ 5,025
- $ 5,000 x 0.5% APY (annual) = $ 5,025
On the horizon
Farming opportunities exist through several blockchains offering various pools and strategies to optimize your returns.
Millions of crypto enthusiasts passively hold crypto in their wallets. However, they haven’t done anything with their assets yet. Additionally, there are billions more who have yet to discover cryptocurrency or this fertile ecosystem.
Decentralized finance and yield farming are available to anyone in the world with an Internet connection. Users deposit their funds and then let the strategies do the hard work to generate passive income.
Suddenly, with automation, things like compound interest are available to a whole new subset of the population. Collaborate to create strategies so that all group benefits are just the beginning of our decentralized financial future.
All information on our website is posted in good faith and for general information purposes only. Any action that the reader takes with the information on our website is strictly at his own risk.