Yield farming refers to liquidity mining. It is can also be translated as a way of locking up digital funds known as cryptocurrencies and getting a passive reward.
In layman language, yield farming is a new investment opportunity in the crypto world whereby one gets more digital assets with the digital assets one has.
It is the act of lending your cryptocurrencies to people through the process of a cryptographic named smart-contract. the reward for lending your fund is that you get rewarded in crypto. Those who lend out their assets are called Liquidity providers(LP).
Yield farming is mainly done through ERC-20 token on Ethereum blockchain but all these can change as we progress because the DeFi application may give room for cross-chain bridges and other development. That is, yield farming might run on any other blockchain that allows smart-contract capabilities.
Because of differences in reward, yield farmer seldom moves from one platform to another in the quest for higher rewards. In the long run, DeFi platforms might bring in mouth-watering economic rewards to entice more investors(the liquidity providers) to their platform.
What leads to yield farming?
The launch of Compound token by the governance of the compound finance ecosystem gave birth to the recent interest in yield farming. And today, many other DeFi projects have launched schemes that entice liquidity providers to their various ecosystems. Although, The compound ecosystem cannot lay claim to inventing yield farming.
What is Total Value Locked(TVL)?
Total value locked(TVL) is the total liquidity in a liquidity pool. TVL is used to calculate how favorable a deFi project is and the total market value of yield farming. Total Value Locked also helps in comparing the market value of different DeFi protocols.
How does Yield Farming work?
Yield farming works around liquidity providers and liquidity pools. Liquidity providers will deposit funds into the liquidity pool, the liquidity pool will create a marketplace where people can borrow, lend, or exchange tokens. To use these marketplaces, a certain amount will be charged and that is the fees they paid the liquidity providers. Apart from the fees, another way to reward liquidity providers is the distribution of the tokens.
The stablecoins such as BUSD, Dai, USDT, USDC are the most common means of depositing funds by the liquidity providers. However, some platforms will rewards back the token that represents the token you deposited. Taking, for example, On Compound ecosystem, if deposit Ethereum, you will be rewarded with CETH, if it is Dai, you will get CDai.
How To Calculate Yield Farming Returns.
Generally, The yield farming returns are calculated annually. Annual Percentage Yield(APY) and Annual Percentage Rate(APR) is the common metrics used in calculating returns.
The main difference between APR and APY is that APY takes into account Compounding but APR does not. Compounding here is not a token but economic terms which means direct reinvesting of profit to generate additional returns. Although, these two terms(APR and APY) can be used interchangeably.
One needs to take note that, it is difficult to get accurate estimation b3cause yield farming is a fast-paced market, the reward keeps changing and it is highly competitive. DeFi may need to find its own metric for calculating because APR and APY are from the legacy market. It will make good sense if the return can be calculated daily or weekly.
What is Collateralization in DeFi?
As we all know, to borrow anything, one needs to present collateral, the collateral serves as insurance for the loan one want to collect. The collateral one needs to present to borrow depends on the platform terms one is borrowing from.
The collateral value must have value than the threshold in order not to get liquidated. Most of the platforms normally used overcolleralization. That is, the person borrowing will use an asset that has more value than the asset the person is willing to borrow. Taking, for instance, one lending platform requires a 200% asset to stand as collateral, to borrow $100, one will use $200 as collateral.
What Is The Risk Of Yield Farming?
Take it to the heart, yield farming is complex, yield farming is good for Whales. Because in order not to get lost one needs huge funds.
Another great threat to yield farming is smart-contract. Many of the protocols are developed by a small group of people with little funds to maintain the protocol. The risk of getting big is high. Because the nature of blockchain is immutable, user funds are at risk. You need to take into consideration many factors such as the teams behind a project, the available capital to run the platform before you go all in.
The Top Yield Farming Protocols And Platforms.
The basic idea of yield farming is that one deposit fund to liquidity pool and get rewarded. It is advisable not just to deposit into any platform but to get familiar with how the platform work. As you know the base rule for winning in crypto is risk management.
The first Defi protocol is Compound Finance. It allows people to borrow and lend assets. Any person with an Ethereum wallet can serve as a compound liquidity provider. The reward starts instantly you enter into a contract.
Maker is another DeFi platform protocol that backed the creation of DAi, one of the stablecoin pegged to USD. ETH, USDC, WBTC, or BAT can be used to open Maker vault. You generate Dai for your locked asset.
Aeve is another great DeFi protocol that lends and borrow asset. The lender gets “tokens” as rewards for their funds. Aave is used heavily by yield farmers.
Uniswap is a decentralized exchange platform that allows trading of token. Uniswap is one of the popular platforms today as DeFi projects keep growing.
Traders trade against the liquidity pools provided by liquidity providers. The liquidity providers earn a reward through the fees that the platform charges traders. Curve Finance, Yearn Finance are other major players in the decentralized ecosystem.
Summary of Yield Farming.
Yield farming is a new investment opportunity in the crypto world. You get more digital assets with your digital asset.
Yield farming is the act of lending your digital assets to people through the process of a technology named smart-contract or it can be simply be named Staking. The reward for lending your asset is that you get rewarded or get paid back with crypto.
Those who lend their asset are called yield farmers or also can be called liquidity providers. Yield farmers are very complicated people, no one can predict their strategies because they move their assets often and often from one platform to another in order to get the maximum return for their funds. You know, the more a working strategy is exposed the less return? Yield farmers are very secretive.
Compound Finance, Yearn Finance, Aave, Balancer, Uniswap are currently the major players in a decentralized ecosystem. One needs to be familiar with the platform one wants to be farming on and at the same time, huge capital is needed to become a farmer.