What Is Yield Farming?
DeFi is the talking point of the cryptocurrency industry in 2020, and yield farming is investors’ go-to method of participating in the trend.
CoinMarketCap presents a beginner’s guide to yield farming and how much is at stake by providing your hard-earned coins to DeFi platforms in return for financial rewards.
Continue reading to get a yield farming 101 as the phenomenon gathers pace.
DeFi Yield Farming Explained For Beginners
Yield farming is a new way of making money with cryptocurrency that has become a major phenomenon this year.
From its sudden explosion in the summer of 2020, yield farming — one of the main investment methods associated with the decentralized finance (DeFi) movement — has built a large community and generated dizzying amounts of value in a matter of months.
What is yield farming? Explained simply for beginners, it’s a way to maximize the potential profitability of your cryptocurrency by putting it to work as a financial tool.
DeFi allows anyone to engage in all sorts of financial activities — which previously required trusted intermediaries, ID verification and a lot of fees — anonymously and for free.
One example revolves around loans. One person puts up cryptocurrency for another to borrow, and the platform this occurs on rewards them for doing so.
With DeFi, platforms have begun not only rewarding via interest on loans and other traditional methods, but also by giving both lenders and borrowers in-house governance tokens.
The combination of these rewards, coupled with the fact that the price of these in-house tokens is free-floating, allows for the potential profitability of lending and even borrowing to be considerable.
The practise of putting cryptocurrency to work in this way, often in multiple capacities at once, is what is called yield farming. There are already practically infinite permutations of yield farming — for example, you can put up cryptocurrency as a loan and then borrow from yourself, maximizing returns and token allocation.
The ecosystem is fleshed out with automated trading markets — computers orchestrating “pools” of tokens to ensure that there is liquidity for any given trade that token holders wish to make. Uniswap is one of the best known of these “automated liquidity protocols.”
Curve is an example of a decentralized exchange which concentrates on stablecoins such as Tether (USDT), and has its own token which borrowers and lenders can receive as a reward for participation — providing liquidity.
What Are the Costs of Yield Farming?
How much can you expect to pay for yield farming? The costs of yield farming are notoriously difficult to calculate given the complexity of the DeFi model. The yield farming model contains inherent risk which varies depending on the tokens used.
In the loan example, cost considerations consist of the original cryptocurrency put up by a lender, the interest and the value of the in-house governance token reward.
Given that all three are free-floating, the profit (or loss) potential for participants is significant. Using stablecoins reduces this, but if the goal is maximizing gains from governance tokens, risk remains extremely high.
There are also secondary considerations, such as the Ether gas price, which has spiked recently, resulting in inflated transaction fees for ERC-20 token transfers.
What’s the best way of knowing how to yield farm with as little risk as possible? Dedicated tools exist to work out the likely cost, for example, predictions exchanges, which monitor changes in non-stablecoin token prices.
Can I Lose Money Yield Farming?
The answer to this — as with any high-risk cryptocurrency trading strategy — is simple: yes. With an attentive strategy and suitable background knowledge, it is possible to keep the risk of loss to a minimum, but not remove it altogether.
A useful comparison is that of the initial coin offering (ICO) craze from 2017, which notoriously punished opportunist investors who put capital into projects without in-depth knowledge of their validity as investments.