Yield Farming is a profitable method of making money from cryptocurrency (tokens) by investing them in liquidity pools (where income is generated from trading commissions) or cryptocurrency deposits (where interest is earned for providing borrowers with deposited tokens).
The process of yield farming involves lending your cryptocurrency as interest-bearing loans or collateral to receive transaction fees. Yield Farming has become a popular method of making money amid the rise of decentralized finance (DeFi).
How it works
The operating principle of yield farming is the participation of users acting as liquidity providers (LPs), providing their cryptocurrencies for the operation of DeFi platforms.
Liquidity providers deposit their tokens into a liquidity pool, a smart contract-based decentralized program where all funds are stored. For contributing to the liquidity pool, they receive a reward or a percentage of the activity of the selected DeFi platform where the liquidity pool is located.
The liquidity pool powers the DeFi market, where participants can lend or borrow various tokens. Fees charged when using DeFi platforms are used to pay liquidity providers for providing their tokens in the pool.
The bulk of profitable farming is carried out on the Ethereum blockchain, which uses ERC-20 tokens.
The profitability of cryptocurrency pharming is estimated on an annualized basis and presented as a simple or compound interest rate:
- The Annual Percentage Rate (APR) is the annual percentage earned by an investor on only the principal amount of the investment, using the simple interest method.
- Annual Percentage Yield (APY) expresses the annual percentage an investor earns on both the principal amount invested and on reinvested interest using the compound interest method.
It is important to consider the risk-return ratio in such operations. Providing liquidity for safe assets rarely guarantees high returns, and vice versa.
Typical risks of income farming
All cryptocurrencies are considered high-risk assets. Even the stability of USDT ERC20 price does not guarantee 100% capital protection. Since this is a very young and dynamically developing industry, this will remain the case for quite some time. Profit farming involves all the risks inherent in the digital asset market, but the most important ones are:
- The possibility of successful cyber attacks on smart contracts with the theft of all user funds.
- Most of the assets that are used in Yield Farming are very volatile. Situations when the depreciation of an asset completely eliminates profits, or even causes losses, are not uncommon.
- Banal fraud should not be neglected either. Creators of little-known DeFi platforms, even with formal decentralization, can abuse access to investor funds.
- The overall profitability of farming is significantly affected by network commissions.
- Profit farming carries significant risks, and investors should evaluate their decisions carefully to avoid potential losses.
What is the difference between farming and staking?
Staking and farming provide the opportunity to receive passive income from coins that you do not trade. From the user’s or outside observer’s perspective, they are not very different from each other. the user locks his coins somewhere and receives a reward for this. However, this is where the similarities end. Technically, these are very, very different processes, so the idea of convert USDT to BUSD and distributing capital between different passive income programs looks quite reasonable.
- Performed to confirm transactions and ensure the security of the blockchain.
- The mechanism involves participation in the functioning of the blockchain, receiving part of the reward for confirming blocks.
- Occurs directly on the blockchain of the token on which staking is done.
- Involves participation in decentralized financial products (DeFi) to earn interest.
- To participate, funds must be deposited into DeFi products, such as a liquidity pool, to receive interest.
- Occurs on decentralized financial platforms, regardless of the token’s blockchain.
So, staking focuses on blockchain security and transaction confirmation, while Yield Farming focuses on participating in DeFi products to earn interest on various transactions, such as making loans or participating in liquidity pools.
How promising is yield farming?
The high profitability from cryptocurrency farming is due to the constant growth of this market and the influx of new investors, but growth is not endless. At some point it will slow down or even stop due to changes in the economy, legislation or investor priorities. Therefore, investors should exercise caution and carefully analyze the risks associated with yield farming, taking into account long-term market trends.