The advent of cryptocurrency has had a revolutionary impact on our economy and has given people new opportunities to invest and earn passive income. While some investors prefer to trade on exchanges, others use various investment strategies to get profit from their crypto assets. One of the most promising and dynamic income strategies is yield farming, which is the process of providing cryptocurrency assets to other users of the DeFi platforms and protocols and earning interest in return. Today's article from Notum will help you understand what yield farming is, how it works, how to generate income using this strategy, and provide you with examples of yield farming platforms you can use.
What Is Yield Farming?
Crypto yield farming refers to the activity of allocating capital to DeFi protocols for profit. Thus, users can participate in liquidity pools, lend, and borrow their coins and tokens, and receive rewards by depositing their funds in decentralized applications.
Depending on the user's chosen cryptocurrency and protocol, yield farmers receive daily, weekly, or monthly interest on their locked assets as a reward. Rewards are given as annual percentage yields (APY) in the form of new coins. Income also varies depending on the amount of assets blocked, the duration of the lockup period, protocol regulations, and other factors. Yield farming is a popular investment strategy as it allows users to passively earn on their cryptocurrency holdings and receive stable high rewards.
How Does Yield Farming Work?
The work process of yield farming is built as follows: the owners of cryptocurrency assets provides a certain number of coins in their wallets or a special program (staking node). The provided coins are deposited into DeFi protocols after which they can be used in lending protocols (through dApps) or DEXs to keep the network up and running transactions. "Other investors can then borrow the coins through the dApp to use for speculation, where they try to profit off of sharp swings they anticipate in the coin's market price." - BusinessInsider. To make it simple, farmers provide their crypto assets for use on decentralized exchanges or DeFi platforms for profit.
Thus, blockchain-based apps offer rewards to users who provide liquidity and stake their coins. Decentralized platforms take deposits from some users and lend them to others who want to take out a loan. Thus, borrowers pay interest, and depositors receive part of this interest as passive income. Such lending is carried out using smart contracts that run on the blockchain and function as liquidity pools. Yield farming is needed to provide liquidity to newly launched blockchain applications to ensure their long-term growth. Therefore, liquidity providers not only receive awards but also contribute to the support and development of various blockchain projects. However, before embarking on crypto yield farming, it is important to choose a reliable and proven blockchain network in order to avoid security risks.
(Image resource: CryptoRobin)
Where Can Farming Be Used?
In 2023, the use of crypto farming continues to expand and now this method of providing capital for profit is used in the following cases:
- Exchanges. Farmers provide their cryptocurrency to create a market on decentralized exchanges and receive commissions in return for transactions. Thus, yield farming on DEXs stimulates liquidity providers to place their assets in liquidity pools by offering them rewards, generated from trading fees, thereby increasing liquidity and participation in the exchange.
- Lending. While some users need a loan, others can lend them their assets. Thus, farming encourages users to provide liquidity for protocols and earn rewards from the cryptocurrency they provide.
- Options. Yield crypto farming can also be applied to options trading, providing traders with additional opportunities to receive rewards from invested assets. Moreover, users can provide liquidity to options protocols to provide traders additional trading opportunities. For example, a decentralized options trading protocol can be established on a blockchain network, which will allow traders to create, buy or sell options contracts.
- Synthetic assets. As in case with options, users can also provide liquidity to synthetic asset protocols, allowing them to earn rewards. In this way, farmers help to form stablecoins and other synthetic assets, as well as maintain the peg or stability of their price, making a profit in return.
Yield Farming vs. Staking: What's the Difference?
As you know, both yield farming and staking are quite popular strategies in the cryptocurrency world and offer opportunities for passive income. Although they are similar in many ways, these strategies also have key differences. Let's talk about the main ones:
- Yield farming involves providing liquidity to decentralized finance (DeFi) protocols and earning rewards in the form of additional tokens. This process requires active management and includes various strategies, such as participation in liquidity pools, lending, borrowing, and others. Moreover, yield farming offers more profit but is also a riskier way to generate income.
- Staking is the process of locking crypto assets in a wallet or platform to keep the blockchain secure and receive rewards in the form of additional tokens or a share of transaction fees. Staking does not require active management and is a simpler and less risky strategy compared to yield farming.
Thus, both yield farming and staking offer users the opportunity to earn passive income. However, the choice of strategy depends on the knowledge of the investors and their experience, preferences, risk tolerance, and goals.
How to Earn Money With Yield Farming?
If you are aiming to generate passive income from cryptocurrency through yield farming, you should start with the following steps:
- Do your research. Explore yield farming platforms and choose the ones that suit your goals and are commensurate with your level of risk. Also, when choosing a platform, consider factors such as profitability (APY), security, commissions, and transparency
- Choose and create a wallet. You need a cryptocurrency wallet that supports the coins needed to participate in staking. Explore the types of wallets and choose the one that best suits your needs.
- Provide cryptocurrency. Once you have selected assets to farm, you will need to transfer them to the yield farming platform. Most platforms provide step-by-step instructions for providing assets.
- Consider the risks. To minimize risks and diversify your investments, it is recommended to distribute your crypto assets among several crypto farming platforms or strategies.
- Track your investments. It is important to check the terms of participation, rewards, and risks from time to time, and monitor your profitability. Based on the collected data, make a decision about your investments.
- Remember safety. Regardless of the chosen investment strategy, it is important to ensure the safety of your cryptocurrency assets and use sound security measures. You can use two-factor authentication, cold storage, and regular software updates.
Among other things, all cryptocurrency investment strategies grow and develop quite quickly. That is why it is important to explore new opportunities and keep abreast of innovations in the world of crypto and yield farming platforms.
Examples of Yield Farming Platforms
As already mentioned, to get started in yield farming, you need to learn the platforms that you can use. Each of them has its own distinctive features, so before choosing platforms for yield farming, it is important to clearly understand your goals and needs. Below you can explore some of the most popular yield farming platforms to look out for in 2023.
- Compound Finance is a DeFi protocol that allows users to lend and borrow various cryptocurrencies. By providing assets to the protocol, users can earn interest and receive COMP tokens as a reward.
- Aave is another well-known DeFi protocol for borrowing and lending, as well as earning interest on a wide range of cryptocurrencies. Aave is unique due to its "flash loans" feature, which allows users to get temporary loans without collateral.
- Curve Finance is a DeFi protocol that focuses on stablecoin liquidity pools and automated market making. The peculiarity of Curve is that users can provide liquidity to pairs with stablecoins and receive commissions for trading. Among other things, Curve offers low slippage and efficient stablecoin swaps.
- PancakeSwap is the leading DEX on Binance Smart Chain (BSC) and offers crypto farming through its liquidity pools. Users can provide liquidity and farm CAKE tokens, the platform's native token.
- SushiSwap also belongs to another well-known DEX and allows users to participate in yield farming by staking their crypto assets. Users can earn SUSHI tokens, the platform's native token, by providing liquidity to various pools.
Pros and Cons of Yield Farming
While yield farming is a popular passive income strategy, it's important to compare the pros and cons before diving into it.
- High Potential Returns. Yield farming offers high returns relative to investments in the traditional financial sector. As users provide liquidity to DeFi protocols, they can earn both trading fees and additional tokens as rewards.
- Diversification of Income. With yield farming, users can use various protocols and liquidity pools to diversify their income. This helps not only to increase the overall profit, but also to reduce risks.
- Availability. This income generation strategy is the most accessible for any crypto owner. Thus, users can participate in the DeFi ecosystem and potentially earn passive income without much capital and experience.
- Market Volatility and Risks. Yield farming, like the entire cryptocurrency market, is known for its volatility. As such, the value of tokens earned from yield farming can vary and lead to some losses in the event of a downturn in the market.
- Impermanent Loss. The value of the tokens in the liquidity pool may change compared to holding these tokens separately. Thus, an inconsistent loss can affect the overall income, especially if the prices of tokens in the pool diverge significantly.
- Risks of Smart Contracts. As you know, yield farming is directly related to smart contracts, which can be vulnerable to bugs or hacks. That is why it is important to conduct checks and choose reliable protocols with minimal risks.
- Complexity. This strategy requires investors to have some knowledge of DeFi protocols, liquidity pools, market dynamics, and more. That is why it can be quite difficult for a beginner to understand the features of crypto farming and the distinctive features of different platforms.
- Transaction Costs. Participation in yield farming also includes frequent transactions, which can be high, especially if the network is congested.
Thus, before starting yield farming, it is important to thoroughly research the market and start with small investments in order to understand the principles of the strategy.
Yield farming is a good opportunity for investors to earn passive income and maximize their profits in the crypto space. This strategy involves receiving rewards for participating in decentralized finance protocols and providing liquidity. However, it is important to remember that crypto farming also comes with its own risks, such as market volatility, impermanent losses, smart contract vulnerabilities, complexity, and transaction costs. If you decide to start your path in yield farming - approach investments with caution, conduct thorough research and evaluate the risks that are acceptable to you. However, by understanding the intricacies of various platforms, managing risk effectively, and staying abreast of market trends, investors can earn good returns through yield farming.
Disclaimer: Notum does not provide any investment, tax, legal, or accounting advice. This article is written for informational purposes only. Cryptocurrency is subject to market risk. Please do your own research and trade with caution.