Yield Farming conjures up images of agricultural activities in the minds of those unfamiliar with cryptocurrency and the blockchain industry. While yield farming may appear to be a bit arcane, the ideas and mechanisms behind it are very powerful and leverage blockchain technology at its best.
Since the DeFi summer of 2020, Yield Farming has become quite the buzzword, and has exploded in popularity across all decentralized finance (DeFi) protocols. Protocols that incorporate yield farming or liquidity mining, as it is also sometimes referred to, allow token holders to put their funds to work. It became so popular that being a yield farmer became a sought after role in the world of decentralized finance. While the protocols behind yield farming projects are oftentimes quite complex and sophisticated, participating in it as a yield farmers is pretty straightforward and can generally be done with minimal effort as long as one understands basic yield farming strategy, governance tokens and liquidity pools. However, it does not come without risks! But we’re jumping ahead of ourselves. So first of all, how exactly does it work, and why all of this agricultural stuff all of a sudden?
In this article, you will learn everything to yield farm, from how yield farming works, its risks, understanding yield farming rewards, liquidity pools, and how it can benefit you as a token holder.
Yield farming, in its most basic sense, refers to any blockchain program that enables somebody with a particular crypto token or coin to 'lock-up' those assets in a smart contract and get other tokens in exchange while always being able to withdraw the locked-up funds. These other tokens, which are more akin to rewards, are frequently distributed as protocol governance tokens. To put it another way, rather than leaving ones’ assets idle, one may offer them to a service provider and receive interest for doing so.
Lending protocols, which provide a peer-to-peer lending/borrowing service, are a prime example of this. The owner lends his crypto assets to a liquidity protocol, which utilizes them in exchange for interest payments. Simply said, in order to earn interest, yield farmers are providing liquidity to decentralized finance (DeFi) protocols such as Curve Finance or plenty other decentralized exchanges. The protocol compensates yield farmers for doing so in the form of yield farming rewards. Supplying liquidity to an AMM - an Automated Market Maker - in return for liquidity incentives – tokens awarded to liquidity providers – is another common kind of crypto yield farming called liquidity mining. Liquidity providers facilitate trades, swaps and stimulate the exchange market for the respective tokens.
Because of Solanas’ incredible efficacy and low cost, yield farming on it is becoming increasingly popular. Because of the low costs, you will have no difficulty cashing out your passive income gains whenever you want. As a result, various yield farming initiatives have been established on the Solana network.
As with any investment, yield farming has several advantages as well as disadvantages that you should be aware of before putting your money into it.:
Yield Farming has become popular mainly due to these three benefits:
Allure of high returns on investment. Many new projects provide prospects for yield farming, with benefits in the form of the project's native tokens. Many individuals want to be in liquidity pools early because the annual percentage yield is usually highest in the beginning. Yield farmers will acquire more rewards in the hopes that the tokens will rapidly grow in value, allowing them to exchange their gains and make a significant profit. Many projects subsidize the bootstrapping of liquidity for projects with additional tokens in the beginning, which significantly benefits early adopters BUT can also lead to many liquidity providers leaving the project once these subsidies are over.
Higher interest rates than fiat banks. As mentioned, furthermore, many Yield Farming protocols and projects provide interest rates that are far greater than those offered by regular fiat banks. As a result, rather than saving money in the bank, an increasing number of individuals are becoming yield farmers and contributing their crypto assets into liquidity pools.
Low maintenance. Yield farming doesn’t demand much from the liquidity provider, besides having a crypto wallet and placing an investment. This makes yield farming even more attractive for those that are looking for a passive and attractive income. However, do your due diligence on any project even the most popular yield farming protocols before using it - you do not want to get rug pulled and lose any of your digital assets. Also, be aware of impermanent loss (see below)!
Low Fee. While yield farming on Ethereum carries the risk of extremely high transaction fees, the same cannot be said about DeFi platforms on Solana. The Solana network offers extremely low transaction fees, which allows users to invest in yield farming without the risk of having to invest too much in fees. You practically only need the amount you wish to add to yield farming platforms to start investing.
As appealing as yield farming is as an investment, it is critical to be aware of its risks too. Every venture carries risks, and yield farming is no exception. It is simply necessary to be aware of them before deciding to invest your money in it. Thus, below are the risks of yield farming:
Cryptocurrencies are Volatile. The extremely volatile nature of cryptocurrencies can affect the returns of yield farmers. In some cases, a platform's reward token may lose value over time, not allowing the farmer to receive the return on his investment. To avoid investing in tokens and coins with high price volatility, make sure you understand the yield farming protocols you are investing in and are convinced of its long-term success. Liquidity providers usually look at the total value locked within a liquidity pool to help avoid some of the extreme volatility accompanying newer and smaller DeFi protocols .
Impermanent loss. When you farm yields on your assets, you are providing liquidity in pairs of equal worth. If the value of one of these assets falls, the coins in the entire liquidity pool adjust to compensate. As a result, anytime you have a massive loss in any of the coins in the pool in such instances, you may wind up with an impermanent loss. This means you will receive a lesser value than you put in when you withdraw from the liquidity pool. The profit from yield farms on your cryptocurrency assets might occasionally compensate for the loss, but it is not always the case. Hopefully, this will only happen if the coin's value plummets dramatically. Small changes will have little impact.
Smart Contract Risk. Smart Contract risk exists in all ventures, and yield farming is no exception. In certain instances, malicious operators strive to steal or "rug pull" yield farmers that engage with the smart contract. This is especially risky for new and untested enterprises that advertise high APYs. Make sure you always invest in yield farming projects that are transparent about their team and have known developers as part of it - best case scenario would be if the contracts have been audited. The majority of yield farming projects on Solana are legit and made by great groups of specialists, just be sure you pick those.
Finally, the concept of Yield Farming is gaining traction and piquing the interest of both the crypto community and venture capitalists. A potential yield farmer may select from several DeFi platforms available on Solana and take advantage of the benefits of this type of investment.
Finally, the key to finding the best yield farming protocols for you is to do your own research (DYOR), ensure that the team behind the project is legitimate and skilled, and choose an investment with prospective returns that meet your expectations.
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Please note that none of this is to be considered financial nor investment advice. We highly advise you to always do your own research (’DYOR’) before interacting with any of the projects or tools we write about. Crypto is a highly dynamic and fast paced environment with lots of moving parts that can quickly change.