Also called liquidity mining, yield farming lets you invest crypto in the DeFi system and earn interest as you lend it out to other users via smart contracts. Working on Automated Maker Market (AMM) principles, yield farming consists of liquidity providers who deposit their funds into a liquidity pool. The liquidity pool is also where users borrow funds from, and they pay a fee for that. The fee is paid out to liquidity providers in proportion to their share in the liquidity pool. They could get paid in new tokens, too, for their share of liquidity in the pool. This is a smart way to make use of unproductive and stagnant crypto assets like stablecoins, tokens, and coins in a decentralized fund.
Borrowers have to ensure that their debts are backed by collateral, sometimes twice the value of their debts. When they already have collateral worth more than their debts, why then do they borrow, you may wonder. More often than not, the debts are for trading, and they are more convinced about borrowing from DeFi users than from banks, debt investors, or VC’s. The bottom line is that yield farming opens up more lending and borrowing options in the crypto verse.
So a yield farmer (yes, that’s what these users are called) is like a traditional bank here – lending funds and offering liquidity to borrowers. Popular for the fast gains it offers, yield farming makes for barrier-free entry and provides easy passive income (not always guaranteed) from idle cryptocurrencies.
Yield farming has become an appealing proposition with its track record of generating interest rates, from a low-key 0.25% for some to more than 142% for other loans. Very recently, Yam, a yield farming platform, reported an in-flow of DeFi tokens worth $400 million in a single day, out of which $11.4 million was from a single transaction of WETH or Wrapped Ethereum.
Often, the funds deposited in the liquidity pool are stablecoins like DAI, USDC, USDT, BUSD, and pegged to the USD. COMP holds the most significant share of the various coins involved in yield farming, followed by Curve, Balancer, Ren, and Synthetix.
Risks – part of the deal
When using smart contracts to lock funds, users need to ensure that they scrutinize the contracts thoroughly since blockchain is immutable, and they could end up losing funds.
- It is more suitable for users with significant capital and well-versed in blockchain, cryptocurrency, and DeFi.
- Bugs in smart contracts could also cause losses, and since small players often have low budgets for creating protocols, their protocols might not be fool-proof.
- Market volatility, which is unavoidable and interest rates fluctuate all the time.
- Highly speculative in nature, YAM and CRV are examples of this.
Introduced only recently, in June 2020 to be precise, yield farming looks all set to move rapidly and yield farmers will reap huge benefits too. Just like any other DeFi product, yield farming also comes with its own advantages and risks, with all platforms having their own rules by which the users need to abide. Sowing your assets for yield farming should be done after deliberation, as it is one of the most powerful and exciting new ways to democratize global financial systems.