Yield farming has become one of the most popular buzzwords of summer 2020. Are you wondering what is yield farming? Here is the answer.
The DeFi market has entered an explosive development phase from the second half of 2019 and continues to maintain that growth momentum from the beginning of 2020 up to now. DeFi market is an increasingly new and innovative service and is gradually replacing the role of banks and credit intermediary institutions. In it, must mention yield farming, a form of crypto lending that brings high profits. This article wants to provide readers with the clearest and most comprehensive knowledge about yield farming, the risks in yield farming, the current popular yield farming forms, and advice for those who want to start earning money from yield farming.
What is Yield Farming?
If you are acquainted with the concept of “DeFi” (decentralized finance), then Yield farming is the next term you must familiarize. In fact, this is rather similar to growing traditional crops.
Comprehensively, yield farming is any push to give crypto-resources something to do and create the most profits feasible for those resources.
In traditionally focused finance, when investors deposit money in banks, investors are actually lending that deposit, and investors will receive interest. With yield farming in the decentralized financial market, investors lend the electronic money they have, in return investors receive interest and sometimes fees. But in the crypto market, interest rates and fees are less important than the fact that investors get more newly issued cryptocurrencies along with participating in these loan and lending transactions.
Along these lines, with yield farming, investors will really get extremely high profits if the currency they get from crypto loans increases rapidly. Similar to the Dutch tulip craze, banks attracted new depositors with the gift of tulips. This explains why yield farming is enticing in the eyes of yield farmers.
Most Popular Yield Farming Protocols
How might you acquire these yield farming rewards? The following is not a comprehensive list, simply a collection of protocols that many farmers are employing.
Indeed, there is certifiably not a set method to do yield cultivating. Indeed, yield farming methodologies may change constantly. Every stage and procedure will have its own guidelines and dangers. In the event that you need to begin with yield cultivating, you should get comfortable with how decentralized liquidity conventions work.
Short-term loans and loans on dApps: AAVE and Compound
Lending money in the money market is the easiest way to make a profit in decentralized finance. Compound and Aave are DeFi’s two main loan and loan protocols. Both protocols together currently account for $1.1 billion in the lending market and $390 million in the borrowing market (figure below).
AAVE
This is a decentralized loaning and acquiring convention to make currency markets, where clients can get resources and procure progressive accrual for loaning as the AAVE (beforehand LEND) token. Aave is additionally known for encouraging glimmer advances and credit designation, where advances can be given to borrowers without guarantee.
Compound
This is a currency market for loaning and getting resources in which algorithmically changed accumulated dividends also the administration token COMP can be acquired.
AAVE usually has a better rate than Compound because this protocol allows borrowers to choose between a fixed rate and a variable rate. Fixed interest rates tend to be higher for borrowers compared to variable rates, increasing the margins for lenders.
However, Compound has launched a new promotion for users through the issuance of additional tokens to COMP. Anyone who lends or borrows on Compound will be rewarded with a certain amount of COMP. 2,880 COMP is issued to Compound users every day. With $250 per COMP at the time of press release, this equates to $720,000 in bonuses per day. This really makes Compound attractive to many investors.
Create liquidity on: Uniswap and Balancer
Uniswap
This protocol is an immensely mainstream decentralized exchange (DEX) and automated market maker (AMM) that empowers users to trade practically any ERC20 token pair without intermediaries. Liquidity suppliers should stake the two sides of the liquidity pool in a 50/50 proportion, and consequently procure an extent of exchange charges just as the UNI administration token.
Balancer
This is a liquidity convention that separates itself through adaptable marking. It doesn’t expect banks to add liquidity similarly to the two pools. All things being equal, liquidity suppliers can make tweaked liquidity pools with changing symbolic proportions.
Uniswap and Balancer are the two largest liquidity protocols in decentralized finance (DeFi), offering the Liquidity Provider fees as a reward when they take the account. Products into the group. Liquidity groups are formed between two assets at a 50-50 ratio in the Uniswap protocol whereas Balancer allows up to eight assets in a liquidity pool with custom allocation on each asset.
Whenever a transaction is made through a liquidity pool on Uniswap or Balancer, the liquidity providers (LP) that have contributed to that pool are entitled to a fee.
The Uniswap protocol has made a lucrative return on LPs over the past year as the volume of transactions on decentralized exchanges has increased. However, profit optimization requires investors to also take into account irregular losses. This is the loss caused by providing liquidity to an asset that rises rapidly.
The Balancer protocol is also able to minimize some anomalous losses, as the liquidity groups on this protocol are not fixedly configured according to the 50-50 allocation. They can be set according to the 80-20 or 90-10 allocation to minimize, but still not completely eliminate impermanent losses. Additionally, users can earn Balancer governance tokens, BAL, for providing liquidity across Balancer protocol pools.
There is another type of liquidity protocol that helps eliminate erratic losses, which is Curve Finance. Curve Finance facilitates trading between assets that are fixed at the same value. For example, there is a pool on the Curve with USDC, USDT, DAI, and sUSD: all stable coins are pegged to the USD. There is also a liquidity pool with sBTC, RenBTC, and wBTC: all tied to the price of BTC. Since all assets are of equal value, there is no impermanent loss. However, the transaction volume will always be lower than the general-purpose liquidity groups like Uniswap and Balancer.
How does it work?
So, how does yield farming work exactly, you are asking?
Well, you may have heard of the term automated market maker (AMM) at a glance, which means automated market creation.
And how does it work? First, the LP provides weapons to the pool, the pool allows users to borrow, buy, and sell, each transaction will incur exorbitant fees, that fee will be sent back to the LP at a percentage rate. Very simple, right?
In addition, DEX exchanges also attract LPs to pour money in by paying additional tokens of value. If you have been farming, you will know, there are many valuable tokens such as: SRM, SUSHI, BAL, Those are very HOT tokens today.
What are the Perks of Yield Farming?
The advantages of yield farming are promptly clear profit. Yield farmers who have the right time to embrace another undertaking can profit by token rewards which will rapidly appreciate in worth within the event that they sell those tokens at the best time, huge additions may be made. Those increases are often reinvested in other DeFi activities to cultivate yet more yield.
Yield farmers for the foremost part have to put down a large estimation of starting funding to make any critical benefits — even numerous dollars will be in question. Due to the profoundly unpredictable nature of digital currencies and particularly DeFi tokens, yield farmers are presented to a critical liquidation hazard if the market out of nowhere drops, because it did with HotdogSwap. Moreover, the simplest yield cultivating methodologies are mind-boggling. Subsequently, the danger is higher for the individuals who don’t completely see how all the hidden conventions work.
Are there any Dark Sides to Yield farming?
The higher the rewards, the higher the risks.
The first is the risk of theft, digital money you lend is held by the software on the dApp, and hackers seem to always be looking to exploit holes in the dApp’s security code to steal that money. Second, some coins that investors deposit for profitable farming are only a few years old, so they can lose value and cause the entire system to collapse.
Another risk is that early investors often hold a large amount of rewarded tokens but their massive move to take profits can have a big impact on the token price in the market. And finally, there is the legal risk: regulators have yet to decide whether these bonus tokens can be converted into the securities of the issuing company, and future decisions of regulators will have a big impact on the use and value of the attached digital currency.
In addition, many yield farming strategies currently with high leverage also have potential risks in liquidity. For example, some investors put DAI tokens they own in dAapp Compound, then borrow DAI using the original tokens as collateral and then continue to lend medium DAI tokens, just borrowed this. The aim is to receive a greater percentage of COMP token rewards. However, just a small change in the token price contrary to the investor’s prediction can wipe all previously accumulated profits and trigger a continuous sell-off.
Conclusion
Although the short-term profit that yield farming brings is very attractive. But in order for it not only to be a trend that will soon bloom and die, but the creators in the DeFi space also need to bring their products practical benefits associated with more life.
Hopefully, we can see yield farming not only in the crypto space but also in the traditional financial flows in the future.
For now, yield farming remains a high-risk, high-reward fashion that might be worth pursuing, as long as the fundamental, necessary research and risk evaluations have been brought out in advance.