Gone are the days when cryptography was limited to a smart few on the Internet. While this is good, as mass adoption will lead to an overall maturation of the industry, it also makes it important to explore options such as yield farming for additional rewards.
If you are wondering what yield farming is, fear not! We’ve got you covered. Stay tuned.
But since we are on the subject of alpha, why not take a look at coin sets? After all, it turns out that investing in indexes is much smarter than investing in individual assets.
What Is Yield Farming in Crypto?
To fully understand the simplicity of this concept, let us break it down. The return is interest. Yes, just like the interest your bank offers on your savings. And farming refers to the various methods developed to maximize this return (interest). So yield agriculture is a set of techniques to increase yields.
Yield farming is even more important in decentralized financing because it offers great flexibility compared to traditional financing. Another aspect that separates yield farming from traditional interest-bearing investments is the yield itself. Yes, it is possible to achieve triple-digit returns. But not all that glitters is gold. These large returns come with high risk and high volatility. In addition, you will often run into scammers who will try to embezzle money from you.
How Does Crypto Yield Farming Work?
It would be fun to make a side-by-side comparison with traditional finance.
You will open a bank account. *sigh*. An endless series of documents and signatures begins. After a while, the bank confirms that you are free to deposit your money. Fortunately, you have to comply with some strange laws regarding minimum balances, minimum initial deposits, lump-sum benefits, etc. All this for a paltry return that barely exceeds inflation.
In a decentralized financial ecosystem, you simply need to have cryptocurrencies available. Once this is done, you can choose from a number of protocols to lock (bet) your money and get a better return. The whole process takes only a few minutes and absolutely no paperwork is required.
Oh, and did I mention that this whole complex tango was started without a central body to control it? Thanks to smart contracts, they execute themselves when certain conditions are met. These smart contracts are immutable because they are built on the blockchain. It is often said that if the blockchain were a city, the code (smart contracts) would be the law.
Another related question that needs to be answered is why these decentralized protocols or applications make these rewards possible. Some of these protocols work like banks. They take your money and lend it to others (in which case your money is safe because of the collateral deposited by the borrower). Other protocols simply encourage participants to create pools of money where traders can come and exchange their assets.
What Are The Different Types of Yield Farming?
There. You have it—the most anticipated section of the article. Let us dive straight into the moolah-making methods via yield farming.
1. Liquidity provision
Have you ever traded on a central exchange? All these exchanges operate with an order book mechanism. In other words, all buy/sell orders are placed in a central book. Someone comes along who is willing to trade their assets at the price you specify, and the trade is executed.
But what happens in a decentralized exchange? There is no central authority to manage the ledger. Moreover, people cannot be expected to ever exchange their assets with you.
Therefore, the industry invented the concept of liquidity pools. The concept is very simple. Some people pool their assets in a 1:1 ratio. Take for example a pool that allows users to trade ETH and USDT, each person can deposit equal amounts of ETH and USDT to maintain the balance of the pool and become a liquidity provider.
Now any trader can come and trade his ETH with USDT and vice versa.
But why should anyone offer liquidity to the protocol? This is where the breeding begins. You get a share of the commissions charged by the protocol. This fee depends on the percentage of money deposited. So if you deposit $100 into a pool with $1,000, you get 10% of the total commission.
This commission is usually paid through coupons from liquidity providers (LPs). Think of them as proof of deposit.
2. Borrowing and lending
Loans and mortgages are the backbone of any strong economy. In the traditional financial world, these loans are mainly made by banks with money deposited by people like you and me. They charge the borrower a percentage of the interest and pay us back by retaining a significant portion for themselves.
Imagine this in the language of DeFi. Now you can directly deposit your money at a fixed annual percentage yield (APY) and create a passive income stream. This APY refers to platforms such as AAVE and Compound. Depending on the cryptocurrency lent, the percentage can range from 1% to 30%. Given that our savings account yields about 3.5 percent and the stock market about 12 percent, anything above this yield becomes very attractive.
Imagine that you have a great investment opportunity, but you need capital to take advantage of it. In a centralized banking system, you can borrow money from a bank. Therefore, you need collateral and decide to mortgage your home. You can leverage the value of your house as the value of your house increases (hopefully).
Similarly, in the cryptocurrency ecosystem, if you are optimistic about the prospects of a certain cryptocurrency but still want to have some capital for other purposes, you can use that cryptocurrency as collateral and take a loan against it. Then, you can pay back the principal and interest and recover the cryptocurrency that (hopefully) has increased in value.
Betting simply means betting one’s chips to get a return. This can be done in two different ways.
First, all proof-of-stake blockchains encourage more participants to bet their cryptocurrency in exchange for voting rights (on who gets to validate the next block) and rewards. This ensures that the network is truly decentralized in terms of geography and participants.
Second, when you provide liquidity to a decentralized pool of exchange liquidity, you are often rewarded with LP tokens. These LP tokens can also be distributed for rewards. protocols such as Uniswap and Sushiswap make this possible.
How to Calculate Returns in Yield Farming?
Ah, back to us. Now it is time to calculate how much money can be earned from all this effort. The returns are presented on an annual basis. In other words, the returns are presented over an entire 12-month period. The terms used to describe this are APY (Annual Percentage Yield) and APR (Annual Percentage Rate). APY takes into account compound interest (you reinvest profits into the contract), while APR does not.
It may seem advantageous to invest in contracts that offer triple-digit APRs, but these rates change almost daily. By design, early adopters of the agreement will receive high returns, and as those returns attract others, the rate of return will decrease.
Because of the dynamic nature of agreements on returns, it is not smart to consider APYs to calculate returns. It is often more useful to calculate returns on a daily/weekly basis.
Few Examples of Yield-Farming Protocols
Now that you know how these protocols operate, it is time to dive into some examples to get you started.
Uniswap is the best-known decentralized exchange in the world. In fact, it ranks fifth in terms of total blocked value ($5 billion).
Traders from around the world flock to trade their assets using liquidity created by people like us. Liquidity providers are rewarded in the form of UNI tokens for providing liquidity. These UNI tokens can also be awarded to bids for additional rewards.
Aave is a lending platform that allows lenders to park their cryptocurrencies in exchange. It has a fixed LTV or total value of $6.5 billion.
The way it works is that AAVE uses a fixed interest rate for loans. If you want to borrow $100 of cryptocurrency, you need to submit at least $120 in collateral. This phenomenon is known as overcollateralization. If the value of the collateral approaches the amount borrowed, it is sold and the position is automatically closed. In this way, the lender’s money is always safe.
Another common question is why someone would borrow cryptocurrencies versus cryptocurrencies. It turns out that one can be optimistic about the prospects of a token and not want to sell it. Instead, one can simply hold that token as collateral and borrow a percentage of that amount to use elsewhere.
Aave also has its own token, called AAVE, which can be used to vote on community governance proposals.
Is Crypto Yield Farming Profitable in 2022?
Agricultural yields are a very dynamic industry. Because yields usually change in a very short period of time, farmers often have to be vigilant and take time to choose the best strategy. However, yield agriculture is very profitable for those who can manage it, even in 2022.
That said, yield agriculture is very risky, and farmers are exposed to short-term losses (owning assets produces higher returns than investing in them), moving mats, and other risks.
Pros and Cons (Risks) Involved in Crypto Yield Farming
Crypto yield farming is still evolving and highly speculative space. Therefore, it is imperative to understand its pros and cons.
Pros of crypto yield farming
Because of its insane APYs, yield farming is an extremely lucrative business. So let us start with that and take you through other pros of yield farming.
1. High APYs
Some companies offer returns of up to 100% of the APR. In general, it is not difficult to find companies that offer 30% returns. Since no other investment vehicle offers such returns, it tends to attract a lot of attention. Daily yields of major deals are available here.
As if all this were not enough, the whole show is run using smart contracts. There is no subjective element. There are no barriers to entry for the rest of the people. Anyone with an Internet connection can join the party. Of course, there is a learning curve, but it is no small requirement.
DeFi Agriculture breaks down the barriers of geographic area. Indeed, when it comes to investment, the origin of the deal cannot be indifferent.
Cons of crypto yield farming
And then there were the downsides. You might lose all your money if you plan to jump in without understanding these risks.
1. Regulatory risks
No government in the world has yet succeeded in regulating the decentralized financial space. The responsibility to declare profits/losses is therefore in the hands of the taxpayer. If investigated, it may be difficult to disclose and explain one’s past transactions to tax authorities.
2. Impermanent loss
Investors are often exposed to a transitory risk of loss due to price fluctuations among assets in the liquidity pool. It is called transitory because one notices this loss only when one withdraws the liquidity. This happens when the value of deposited assets changes from when they were deposited. When you deposit into a liquidity pool, you contribute a share to the total pool, such as 20 percent. If the value of the cryptocurrencies in that pool drops due to market fluctuations, you are still only entitled to a 20 percent share, which may be worth less than the value at the time of deposit.
In such a case, simply holding the asset gives a better return (or reduces losses) in case of a fluctuation.
3. Scams and frauds
For some reason, scammers are often one step ahead of small investors. Yield crops are home to some of the biggest scams in this area. If you think we are spreading paranoia, here is a website that tracks scams and fraud in this area.
What Next? How Do I Get Started With Crypto Yield Farming?
Finally, the moment has come. If you are all set and want to jump right into the world of juicy APYs. This section will help you prepare for that. Let’s go.
Step 1: Prepare and research
Think it’s enough to choose the platform with the highest return and move your funds into cryptocurrency? Well, that’s not how we do things here. You might want to know the history of the protocol, the team, audit reports and reviews.
You should also study tokenomics, otherwise you may end up with high returns in the form of worthless tokens.
Step 2: Setup your wallet
Have we mentioned before that you cannot tap the true potential of yield farming with a centralized exchange? It is necessary to create a decentralized wallet, such as Metamask/Trust’s, and send you the data of the cryptocurrencies to be exchanged.
Step 3: Stake and make
The next step is to place cryptocurrencies in the right proportion and do due diligence. Also, do not forget to collect your rewards. Many platforms accumulate rewards and require you to collect them manually.
1. Is yield farming the same as liquidity farming?
Yield farming is a set of techniques used to maximize the returns of a particular cryptocurrency. It can also include liquidity farming as one of the techniques. Liquidity farming, on the other hand, focuses solely on maximizing returns by providing liquidity to the DEX liquidity pool.
2. What Is APY in yield farming?
APY is the annual percentage yield. This is the annual interest you would get from an investment, taking into account compound interest. It is a difference from the APR or annual percentage yield, which does not take into account compound interest.
3. What Is DAI in yield farming?
DAI is a stable currency that is often used to cultivate returns. People can borrow DAI by depositing collateral in the form of various cryptocurrencies. This is enabled by a protocol called DAI Maker. People can deposit specific cryptocurrencies and receive DAI in return.
4. Where can I do yield farming?
There are several platforms where tokens can be borrowed/used to get results. Some examples are Uniswap, Sushiswap, MakerDAO, AAVE, and Curve Finance. CoinMarketCap shows the shares of some of the top companies. Based on this information, an analysis can be made.