What is Yield Farming?
Before a definition of yield farming is given a definition of decentralized finance must be given . To understand yield financing one must have a working knowledge of decentralized finance. Decentralized finance is the way the monetary system works in the digital world . It is an entity that is not owned by one central company or person on the internet.
It is a new monetary system that is being created on public blockchains. Public blockchains allow anyone to download the transactions of every user involved in the blockchain. Thousands of computers will share the same financial records no matter where those people are located in the world. There is no one centralized financial institution that controls the collective financial resources of its users. Each user can control their own finances and hold onto them all the time which makes DeFi platforms (if audited and without bugs) more secure than traditional financial applications. Also learn more about practical DeFi usecases here.
Yield farmers operate within the confines of the decentralized finance system and is the new term for investing and earning returns on those investments. Those investments are confined to decentralized finance platforms. Yield farming is defined as putting your crypto currency assets to work for you in various decentralized platforms and earn the biggest yields on those crypto assets. People who use their assets like this are called yield farmers.
Yield Farmers can leverage Etherscans Yield Farming calculator to get a grasp what their expectations might be. You can find it here.
Origins of Yield Farming
Yield farming started with a Chinese platform called Fcoin in 2018. The pool encouraged users to join the platform and trade so the users could earn coins the pool developed. If the investors made trades they would earn the coins. Needless to say the policy yielded a lot of meaningless trades among users which called washtrading and is highly illegal in traditional financial markets. They would make pointless trades to earn the coins. But they transacted these meaningless trades to increase the yield on their investment. This is another form of yield farming, yet not in a decentralized fashion.
Liquidity Mining and why Yield Farming is so hot right now
Yield farming is so popular right now because of another process known as liquidity mining. A yield farmer can earn extra yield by setting their liquidity in a certain pool and the pool will give them the usual return for the use of their resources. But the mining part comes in because in addition to the normal return the yield farmer will be given a coin..
Their liquidity will earn them financial yields through trading or if they loan their liquidity to other users within the pool. A user can secure a loan on one of the pools and earn money on the loan. These are processes found in normal operating platforms but there are platforms that will offer yield farming rewards out of the box such as Uniswap which offers liquidity pools by default on all markets.
Compound – one of the largest DeFi platforms – wanted to decentralize its product by giving ownership of it to users within the platform. They basically wanted to reward people for using its platform. People who made the platform popular by using it. They came up with a unique 4 year program. For those four years the owners of the platform would give a certain amount of COMP tokens daily to users until these amounts were used up.
The COMP token is the controlling factor by users in the platform. It is like shareholders controlling or owning stocks in public trading companies. The users own the protocol and can vote on pertinent issues within the platform. They will also lend their assets to other users in the platform. The owners of the platform would look at the activities of its users . They would look at how much money the users loaned or borrowed from the platform and they would reward the users with COMP tokens based on the proportion of business the users conducted on any particular day.
For instance, if a user loaned a higher percentage of money on the platform then another user borrowed then the user who loaned the higher percentage of money would receive a larger amount of COMP tokens. The busier a user is on the platform the higher yield they will attain.
How does Yield Farming work?
Yield farming is the new buzz word in the cryptocurrency world. But is much more than just a word. It is a financial process by which “yield farmers ” will look for the most lucrative opportunities in various pools to earn the biggest yields on their cryptocurrencies.
The most basic form of yield farming is when a cryptocurrency yield farmer will move their cryptocurrency assets around within a compound to earn the highest APR rates they can. Another example of farm yielding is when an investor will loan their cryptocurrency to a pool and the pool may give them a coin for their liquidity assets.
A more complex example of yield farming is a cryptocurrency investor may purchase $50,000 worth of USDT (which is a coin issued by Tether and this coin will be accepted on some exchanges) and put it into compound and that pool will give the investor a coin in return. Their liquidity is now labeled cUSDT which means they now have $50,000 plus the coin. They can take the cUSDT 50,000 and invest it into a pool that will accept that form of cryptocurrency and then they can earn interest on the amount at whatever set rate the pool has established.
Some pools will encourage yield farming by give incentives to users who allocate their liquidity into the pool and leave it there for a set time. This will earn the investor a higher rate because they kept their investment in the pool for a long time.
Yield Farming – Conclusion
Yield Farming often seems very lucrative – especially when you hear of people making thousands of percents in a very short amount of time, however, keep in mind that the more leverage you use the more likely you are to loose all your money – similar to margin trading.
Additionally, bare in mind that most platforms are unaudited and even if they are there is always the possibility for hacks or “rug pulls” that might make you loose all your money.
As always – nothing that seems is too good ot be true is really that good.
Disclaimer: None of this is financial advice. All content on this website and this article is provided for informational purposes only. You must consult your financial advisor first before making any financial decisions. Image Source: Unsplash.com