What is Yield Farming?

Table of Contents

What is Yield Farming?

Yield Farming is a general term used in decentralized Finance – DeFi, that simply means earning a return on invested cryptocurrency.

Users also known as farmers will earn a revenue or yield by allocating their crypto to certain DeFi protocols. The ways in which a yield can be earned are “endless” and range from simple to very complex.

Yield farming can be done on different DeFi blockchains and protocols. For example, one will be able to invest cryptocurrency on decentralized exchanges, loan markets, money markets, or crypto staking.

Yield-farming-farmer

What do we consider to be yield farming?

Yield Farming can be done in various ways. Since this topic cannot be summarized in one article, we will take a closer look at the most important and simple yield farming strategies.

  • Staking
  • Lending
  • Liquidity Mining

What is staking?

Staking is when you lock tokens for a specific time in order to support a blockchain network or DeFi protocol. This will be especially common for blockchains with the Proof-of-Stake –  PoS consensus mechanism where validators need staked tokens to verify transactions. By simply being rewarded when staking tokens, this is one of the easiest ways to earn a return.

What is lending?

Lending happens on DeFi lending protocols and is characterized by earning interest on lending cryptocurrency. A lending protocol will offer lenders interest on securing their tokens on the platform. These tokens will then be loaned out to other users.

Those seeking a loan will not be able to access additional capital until they collateralize a portion of their own tokens. This is called the ‘over collateralization‘ principle, meaning that users only can borrow a certain percentage in relation to their collateral.

For example; When you have a a collateral of 100 USDT, you will be able to borrow 70 USDT.

What is liquidity mining?

The arrival of decentralized exchanges has changed the way liquidity is provided. The decentralized exchanges use automated market makers (AMMs), where users who provide liquidity will be rewarded with LP tokens.

For example; If you own a 1% share in the USDC/ETH pool, you will receive 1% of the USDC/ETH LP tokens.

In addition to earning a percentage on transaction fees of the pool, users can start using their LP tokens to further maximize their revenue. Many protocols use staking mechanisms to reward liquidity providers (LPs), also known as incentives. 

Because LP tokens are not locked, liquidity providers can use their LP tokens in different ways. This opens up numerous opportunities for yield farmers as they can use their LP tokens to maximize their yield.

Bitladon-staking

Conclusion

Yield farming is characterized by earning an interest or return on locked cryptocurrency into DeFi protocols. Remarkably, yield farming generates financial returns that are much higher than traditional investment opportunities.

Because the DeFi space is quite volatile and very new, yield farming not without risk. As a result, you need to educate yourself on the different opportunities and associated risks.

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