What Is Yield Farming in DeFi? How It’s Done [2024]
Growing interest in decentralized finance or DeFi makes it essential to comprehend what is yield farming in DeFi in the contemporary context of DeFi. Yield farming is a process through which the holders of cryptocurrency can receive extra value in the form of gains of staking or lending their tokens in the decentralized finance space. In the following blog post, I will give you a more detailed insight into what yield farming is and how it works and I will showcase the different platforms where it is currently happening, as well as the potential benefits as well as the possible downsides of yield farming.
How Yield Farming Works: Creating Returns from Crypto Assets
Understanding what is yield farming in DeFi starts with profound knowledge of how it empowers users to make profits through cryptocurrencies. Yield farming is the process through which people can offer their tokens for lending and receiving incentives in return involving providing liquidity to DEXs or lending platforms. These rewards are mostly received in the form of more tokens or interest that would significantly increase the income on an individual’s cryptocurrency investments.
For instance, in the year 2020 Compound introduce the concept of yield farming by offering its users COMP tokens if they provided funds to the network or borrowed assets from it. Whenever users deposited stablecoins such as USDC or DAI in Compound, they could also receive an interest on their deposits as well as COMP tokens to use within the platform. With this two-tier process, there was high adoption of Compound with TVL standing at more than one billion USD by mid-2020.
In yield farming, one engages with the smart contract on the DeFi platform where the user deposits her tokens into a liquidity pool. These assets are then utilised by the smart contract in tasks such as lending and borrowing or trading within the platform. For this, the platform shares a portion of the transaction fees or governance tokens; the currency can be either sold for profits or staked for additional rewards.
A perfect example of yield farming is in operation on Uniswap, which is one of the best DEXs available to users today, which involves people putting their tokens and token pairs into liquidity pools. For instance, a user may wish to staking thesame value of Ether (ETH) and USD Coin (USDC) in the Uniswap liquidity pool. In exchange for this, the user receives a cut of the trading fees of the pool as well as extra incentives in form of UNI tokens. It also ensures the recovery of excess liquidity in decentralized exchange while users can earn streams of passive income.
The Risk and Rewards of Yield Farming
Although, it is essential to understand that there are also inherent risks associated with yield farming which must also be taken into consideration. Exploring what is yield farming in DeFi also requires one to consider the benefits that are going to be earned against the risks in the process. Yield farming can thus be quite lucrative while at the same time being anchored on certain pitfalls that the user should lookout for.
Another major benefit of yield farming involves the high yields that one is able to generate on his/her crypto assets which are usually much higher than the interest rates that are given by traditional banks. For instance, at the time of the DeFi craze in summer 2020, the Yearn Finance yield farming returned more than 1,000 percent APY on some of the strategies. The mentioned high returns influenced a relevant inflow of capital to DeFi and affected increases in the total amount of value locked up in protocols.
Nevertheless, yield farming was always associated with high returns which in turn corresponds to high risks. The most apparent is impermanent loss, which takes place when the price of the tokens deposited in a liquidity pool varies from the time that they were locked in. This can lead to a lower value of the deposited tokens when they are withdrawn that may offset the gains that one gets from yield farming. For instance, a user adds liquidity and deposits ETH and a relatively volatile altcoin into a pool; in case the altcoin’s price collapses, a user might suffer impermanent loss while withdrawing his/her assets.
Smart contract vulnerability is another risk that comes with yield farming as shown below; Another risk associated with yield farming is the fact that the process utilises smart contracts which handle and distribute the rewards, however, any vulnerabilities in the code used in the contract means that losses are inevitable. An example of this risk is the Yam Finance protocol that in a short time managed to attract millions of dollars in liquidity, but after an attack on its smart contract was a critical bug. The bug made it possible for more YAM tokens to be minted thus leading to the failure of the project and participants losing their money.
However, these risks have not deterred most users from engaging in the yield farming because of the huge returns that are possible in the process. Thus, users can somewhat reduce potential risks and enhance the possibility to receive high yields through proper selection of platforms, detailed research, and proper distribution of yield farming services.
Yield Farming Real Platforms in DeFi
When researching yield farming in DeFi or defining what yield farming means, more focus should be paid to real platforms where this process occurs. Some of the most popular DeFi projects have appeared as yield-farming platforms that allow users to receive additional rewards by adding liquidity or staking.
But one of the most important and famous platforms to yield farming it is Uniswap if one wants to supply liquidity for decentralized exchanges. Recall that Uniswap enables users to deposit tokens as a pair for liquidity to pool and earn trading fees and UNI coins. Due to simple UI and high token compatibility, Uniswap became one of the go-to platforms for yield farmers to gain the highest revenues.
Another popular platform is Aave, an underlined lending marketplace that allows users to both lend and borrow a large number of tokens. Liquidity mining also exists in Aave protocol through its liquidity mining program that grants extra incentives in form of AAVE tokens to users who supply or borrow assets in the platform. In 2021, Aave incorporated features such as collateral Type/SWAP as well as credit delegation hence boosting the willingness of yield farmers.
Another major platform in the realm of yield farming is Yearn Finance which focuses on the use of automated yield optimization techniques. Yearn Finance is a DeFi protocol that pulls together liquidity for several decentralized money-making platforms and then reinvests the funds into the best possibilities. Such an approach ensures the users achieve great returns on their investments without engaging in tedious and cumbersome yield farming. In doing so, Yearn Finance’s native token, YFI, became a sensation in early 2020 when its price surged through the roof, briefly crossing the $90k mark, thus signaling the success of the platform in the DeFi market.
SushiSwap a copy of Uniswap was also turned into a yield farming hub quickly. Yield farming available at SushiSwap bundle consists of staking SUSHI to receive extra rewards. These key features include Onsen, that is a liquidity mining program designed to encourage users to provide liquidity for specified token pairs and are today a major asset to the platform. Addition to the value exchange, in early 2021 SushiSwap added the lending and borrowing facilities with BentoBox and Kashi protocols respectively.
Lastly, PancakeSwap DEX on Binance Smart Chain (BSC) has emerged as the go-to platform for yield farming owing to low gas fee and instant transactions. Liquidity providers on PancakeSwap are also able to supply their tokens to different pools and they get rewarded in terms of CAKE tokens. This was mainly because PancakeSwap started getting more attention as a yield farming platform than Uniswap since the later had very high gas fees on Ethereum network in 2024.
How To Get Started With Yield Farming
Yield farming is a new concept and many people do not know how to participate in it; the following are guides on how to get started with yield farming. It is vital to learn how to begin with yield farming in DeFi when explaining what yield farming is in DeFi as well. For those who are new to yield farming, usually, one starts by choosing the right platform and then determining which assets to deposit in a liquidity pool or stake to earn rewards.
The first step is to select the platform that fits one’s risk profile as well as investment objectives. As seen earlier, Uniswap, Aave, Yearn Finance, SushiSwap and PancakeSwap are among the finest yield farming platforms. Every site has its peculiarities and system of incentives, therefore, it is vital to take time and search for the most appropriate site.
After that, you’ll have to link an accepted cryptocurrency wallet to the platform you’re using or planning to work with. For instance, there is the MetaMask wallet that is compatible with most of the DeFi projects based on Ethereum, while Trust Wallet is compatible with the Binance Smart Chain projects. This means that after you have connected your wallet, you deposit the coins you desire to be a part of an SIP or as staking assets.
It also would be good to always check on your yield farming activities now and then to check whether everything is in order concerning your goal. Make sure that you are a close watcher of the rewards that you are accruing as well as the overall value of the assets that you have placed with the company. If the market changes or if you endure heavy impermanent loss, then you may have to exit the game or re-strategize how to avoid additional losses.
Last but not the least, one should always be wary of the danger of yield farming. Smart contract drawbacks are possible, and impermanent loss, as well as instability in the markets, will reduce your earnings. In this way, it is possible to create more opportunities for successful yield farming activities thanks to the constant overview of the situation, comprehensive research, and tangible diversification of approaches.
Conclusion: The Potential and Risks of Yield Farming in DeFi
To start with it is crucial to comprehend what yield farming in DeFi is all about especially for anyone who intends to be involved in Decentralized finance space. It remains one of the ways through which users can make good profits in DeFi by providing liquidity or staking their assets has its downside that users must be careful of.
Indeed, many new DeFi projects can be observed in the real world, including Uniswap, Aave, Yearn Finance, SushiSwap, PancakeSwap, and so on, which do exist in the yield farming area. But, such price risks as impermanent loss, the risks of smart contracts, and the variance of market prices are always there.
Apart from risky endeavors, yield farming is hard to beat since they are quite profitable and can help you build your crypto collection while earning passive income at the same time. To increase your chances of earning high yields in the world of yield farming in DeFi, it is advisable to choose the right platforms and use different approaches while taking into consideration the current trends in the market.
