The cryptocurrency space is one of the most dynamic industries that is constantly navigating through new trends and buzzwords. Amongst its numerous trends, Decentralized finance (DeFi) — a growing financial technology that seeks to eliminate intermediaries in financial transactions — has opened up multiple avenues for investors to earn passive income. One of these avenues is yield farming, an investment strategy in DeFi where investors have to either stake or lend their crypto assets in exchange for rewards or interests.
One of the major contributors to the boom in yield farming can be attributed to the COMP token, a governance token of the Compound Finance ecosystem. As more and more platforms continually brought up solutions to enable investors to earn interest, the idea behind yield farming continued to spread, giving potential yield farmers an incentive to provide liquidity in various pools.
According to coincodex.com, the market capitalization of the yield farming industry is currently worth $8.33B, and this represents 0.87% of the total cryptocurrency market cap. In this article, we will be looking at yield farming, benefits and risk, and yield farming platforms you can utilize.
Yield farming is the process whereby a crypto holder locks up their crypto assets in order to earn more as passive income or rewards. Simply put, yield farming is a process that allows investors to earn either fixed or variable interest by investing crypto in a DeFi market. By doing this, you are essentially adding liquidity to a platform and earning rewards in the form of interest. Similar to traditional finance where loans are given with the expectation that they would be paid back with an interest, yield farming follows the same process. The difference here is that it is done via a DeFi protocol and locked into smart contracts in order to get a return.
Additionally, there are various reasons why yield farming is often implemented:
- It is often utilized as a means to incentivize investors to deposit and provide liquidity to a DeFi protocol with the aim of growing the platform’s TVL. For instance, as more liquidity is made available on a decentralized exchange, it reduces slippage for users and reduces the volatility of certain tokens.,
- Distribution of a DeFi application’s native/governance token to protocol users who utilize the opportunity of depositing their funds on the platform. This encourages greater participation in decentralized governance processes.
Yield farming gives investors the opportunity to lend their tokens via a decentralized application (dApp) powered by smart contracts, holding all the funds with no middleman or intermediary involved. In the world of yield farming, investors who provide their crypto assets to support the functionality of a DeFi protocol are referred to as liquidity providers (LPs).
These LPs lock their crypto assets into a liquidity pool on the DeFi platform to earn a fee or generate interest. . The distribution is dependent on the unique implementation of the protocol. The main thing here is that liquidity providers will get their returns based on the amount of liquidity they provide to the pool.
It is important to note that the percentage may decrease depending on the platform as more people commit their crypto coins or tokens to that liquidity pool. Also, liquidity provisioning is constrained by the network the platform is hosted on. For instance, if you provide liquidity on a DeFi platform built on the Ethereum network, rewards can only be issued as ERC-20 based tokens, and the same goes for other various networks.
- With yield farming, you can easily earn passive income on crypto
- It offers a wide range of opportunities to investors, from conservative low-yield farms to aggressive high-yield farms.
- Users get the opportunity to participate in DeFi protocol decisions via governance token rewards
- Opens-up users to DeFi education and builds a base layer of skills that will help many investors understand the future of DeFi innovations.
Price volatility: The cryptocurrency market is highly volatile and the market value of the tokens or coins you are depositing into a liquidity pool may either rise or fall (except if it’s a stablecoin). If the reward token issued to you loses its value, you may have wasted an ample amount of time and funds that may have been utilized in a much more valuable farm or pool.
Smart contract risk: In the world of DeFi, smart contracts represent a crucial part of a project. Smart contracts are mainly dependent on the code quality and the developer teams’ skill and experience. If the smart contract is not carefully programmed to be void of bugs or properly audited by a good and reputable auditing firm, hacks on the DeFi protocol will be inevitable hence, leaving depositors vulnerable to loss of funds.
Impermanent loss: In periods of high volatility, liquidity providers most times experience impermanent loss. It happens when the price of a token in a liquidity pool changes, subsequently converting the ratio of tokens in the pool to stabilize its total value.
Rugpull risk: This happens when malicious actors decide to launch a token only to defraud unsuspecting investors of their funds before abandoning the project. Rugpulls happen in different ways. These malicious actors may remove a considerable portion of the liquidity from an AMM, prevent investors from selling in the token’s contract, or they go ahead to mint a significant amount of new tokens, hence creating an excessive supply and so much more.
Yield farming platforms are relatively easy to navigate, particularly with the special attention paid to building friendlier user experiences for non-technical investors. However, there are some that need further guidance before they can be utilized. Take UniSwap V3 for example. To start earning yield on your crypto assets, you may;
Be required to download a software wallet like Metamask or Trust wallet.
There’s a need to purchase either Ethereum or BNB or CET(depending on the host network) to cover transactions fees
Once that is set, go to a yield farming website of your choosing and click “Connect Wallet”.
Once that is settled, locate the pool or farm you want to deposit in and follow the instructions the platform provides
Do well to stay up to date on any major price fluctuations in case it incurs impermanent loss.
CoinEx Smart Chain (CSC) is a decentralized and efficient public chain created by the CoinEx team for decentralized finance. The public chain, perfectly compatible with the Ethereum ecosystem, features high efficiency, low fees, as well as permissionless validators. All developers can easily build their own decentralized applications based on CSC or quickly deploy their EVM applications on CSC.
Yield Farming is one of the most interesting ideas in the world of cryptocurrencies where investors can earn passive income from their idle cryptocurrency assets without providing a KYC requirement. As its benefits are undeniably attractive, it is also important to pay attention to the risks involved. Earning 100%, 200%, or more in annual interest can be very enticing. However, it is important to carry out your due diligence and you should not participate unless you fully understand how yield farming works, the risks involved, and the teams behind the yield farming platform. DYOR.
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