Yield Farming: What Is It and How Does It Work?

Others use Delegated Proof of Stake (DPoS), where users vote for delegates to validate transactions. Tezos (XTZ) uses DPoS, allowing users to delegate their coins to elected representatives and earn rewards based on the delegate’s performance. The easiest way to become a staker and start earning staking rewards is through a crypto exchange like Coinbase using its wallet. A yield farmer is a lender when they lend cryptocurrencies to borrowers using a smart contract and through platforms such as Compound or Aave, eventually realizing yield from the interest paid on what is defi yield farming the loan. Liquidation occurs when the price of the collateral falls lower than your loans’ value, meaning that your collateral doesn’t cover your investment anymore. If this happens, the exchange will automatically close your position and, depending on how much the price drops, you might lose a great chunk of your investment.

Title:Reap the Harvest on Blockchain: A Survey of Yield Farming Protocols

This tutorial will teach you the fundamental knowledge you need to successfully navigate the fascinating world of yield farming, regardless of your level of experience with DeFi. In the DeFi metaverse, you will likely encounter terms like staking, yield farming, and liquidity mining. These concepts involve clients committing https://www.xcritical.com/ their resources to support blockchains, decentralised exchanges (DEXs), or other decentralised applications requiring capital. This kind of asset is called a governance token, and it offers holders voting rights that give them power over platform changes. Interest in the token jump-started its popularity and moved Compound into the leading position in DeFi.

Impermanent loss and impact on returns

Regulatory scrutiny has also forced MakerDAO to reconsider its strategy for issuing DAI stablecoins. A new yield farming trend that has emerged with the rise of NFTs is NFT farming. Farming NFTs involve staking non-fungible tokens in a staking contract for a reward paid in tokens or staking tokens for a reward paid in the form of an NFT. Since the decentralized finance (DeFi) industry’s breakthrough year of 2020, the total value locked in DeFi apps has skyrocketed up to almost $100 billion at the time of writing.

• For example, suppose you want a new savings account that offers the highest annualized percentage yield.
• More risk-seeking investors comfortable with volatility and active portfolio management tend to favor farming to maximize yields through complex, optimized strategies.
• Based on the trading pair you choose, you can also be exposed to sizable yields that are more than what other methods offer.
• Like dividend payouts, in case the price per asset grows, the yield paid on your cryptocurrency provides users with new tokens; they cost more money.
• Synthetic assets can be thought of as tokenized derivatives that use blockchain technology to replicate the value of their underlying assets.

Benefits and Risks of Yield Farming

An LP will obtain a more significant portion of the profits the more they contribute to a liquidity pool. Cross-chain bridges and other related developments might, however, eventually enable DeFi apps to be blockchain-independent. This implies that they might function on different blockchain networks that facilitate the use of smart contracts. Yield farming is a way to earn extra financial rewards with crypto holdings. During the past few years, yield farming and liquidity mining have become popular ideas. Although both of these terms are widely misinterpreted, they are very different from one another.

Yield farms allocate cryptocurrencies across smart contracts that have not necessarily stood the test of time or been audited for bugs. The complexity heightens risks of exploits, hacking vulnerabilities or code glitches that drain funds. In addition, assets moved across different protocols can become quickly devalued if prices crash. Yield farming offers an opportunity for individuals to earn passive income. Yield farming allows investors to earn yield by placing coins or tokens in a decentralized exchange (DEX) to provide liquidity for various token pairs. Yield farmers typically rely on DEXs to lend, borrow, or stake coins—an exercise that allows them to earn interest and speculate on price swings.

Smart contracts are used on the DEXs to lock tokens loaned for yield farming. Maker is a decentralized credit platform that supports the creation of DAI, a stablecoin algorithmically pegged to the value of USD. Anyone can open a Maker Vault where they lock collateral assets, such as ETH, BAT, USDC, or WBTC. They can generate DAI as a debt against the collateral they have locked. This debt accrues interest over time, called the stability fee, at the rate set by Maker’s MKR token holders. Yield farmers may use Maker to mint DAI for use in yield farming strategies.

The amount each provider receives is proportionate to their share of the total liquidity pool on the protocol. Even if you are yield farming on reputable DeFi protocols, smart contract risk, and hacks could still lead to a complete loss of funds. Yield farming refers to depositing tokens into a liquidity pool on a DeFi protocol to earn rewards, typically paid out in the protocol’s governance token. Yield farming is one of the most popular yield-generating opportunities in the global DeFi markets, enabling you to potentially earn above-average yields by depositing crypto in yield farming protocols. An example of trade mining innovation is Integral, a hybrid decentralized exchange utilizing an AMM/order book model.

To get started on your yield farming or staking journey, simply buy crypto via MoonPay using a card, mobile payment method like Google Pay, or bank transfer. Since most cryptocurrencies are open source, the source code is publicly accessible, and security issues are always likely to happen. Technical flaws could allow hackers to exploit DeFi protocols and steal finances. Kamino has solidified its position as the leading money market on Solana and is emerging as a DeFi bluechip. Although DeFi competition is fierce, Kamino has kept iterating on its product to provide the best-in-class UX, paired with a robust risk management framework and battle-tested infrastructure.

The comments, opinions, and analyses expressed on Investopedia are for informational purposes only. As of the date this article was written, the author does not own cryptocurrency. Cryptocurrency exchange Kraken shut its U.S. staking-as-service business after regulatory action by the U.S. Coinbase is also under regulatory scrutiny but maintains that its staking services are not securities. Get crypto market analysis and curated news delivered right to your inbox every week. Contact us right away to know how our pros can transform your business with custom software development services.

This occurs when the price of a token in a liquidity pool changes, subsequently changing the ratio of tokens in the pool to stabilize its total value. Volatility is the degree to which the price of an investment moves in either direction. A volatile investment is one that has a large price swing over a short period of time. While tokens are locked up, their value may drop or rise, and this is a huge risk to yield farmers especially when the crypto markets experience a bear run. “Yet, despite these risks, the high yields are undeniably attractive to draw more users.” With yield farming, the goal is to maximize a rate of return on capital by leveraging different DeFi protocols.

For example, let’s say you provide $100 of Ether and $100 of DAI ($200 total) to the liquidity pool, which has a total value of $20,000. If the amount of fees collected on exchanges between Ether and DAI for the day are $100, you’ll earn $1. If you believe in the long-term potential of a blockchain project using the proof-of-stake system, you may be interested in buying the native token and staking it to earn additional rewards. Borrowers can use lending protocols — such as Compound (COMP -3.89%) or Aave (AAVE -6.92%) — to take out loans against their crypto assets.

Curve keeps its APRs high, ranging from 1.9% (for liquid tokens) to 32%. As long as the tokens don’t lose their peg, stablecoin pools are quite safe. Impermanent loss may be entirely avoided because their costs will not alter drastically in comparison to each other.

Despite its allure, yield generation remains a contentious topic in crypto circles. While some view it as a significant advancement, others caution against its risks. Flash farms, for instance, have drawn criticism from Ethereum developers due to heightened risk levels.

Yield farming has been quite popular after the successful introduction of Compound in 2020, a lending and borrowing marketplace for cryptocurrencies on the Ethereum blockchain. In order to reward users who actively participated in the platform’s market-making activities, Compound developed its native coin, $COMP. With decentralized finance (DeFi) transforming the conventional financial scene, yield farming has become a profitable venture for investors looking to optimize their profits. We’ll dive into the context of DeFi yield farming in this beginner’s guide, explaining what it is, how it operates, and any possible hazards or rewards.