Yield Farming Explained
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While exploring potential methods to expand your cryptocurrency asset portfolio, you must have come across the concept of Yield Farming. If you have invested in specific cryptocurrencies and want to churn out a significant profit, Yield Farming may be a good option. However, it is essential to understand how Yield Farming works before you jump right on the bandwagon.
In this article, Liquid has prepared a detailed guide to Yield Farming. We will also guide you through how to get started with Yield Farming, in addition to critical things you should be aware of.
What Is Yield Farming?
Yield Farming is a process in Decentralized Finance (DeFi) where a user can earn rewards for locking up their tokens in a Liquidity Pool designed and controlled by smart contracts that handle the ‘trust’ part. Other users may use the cryptocurrencies added to these liquidity pools utilizing lending, borrowing, staking, etc.
In the end, Yield Farming can benefit people at both ends. For those who want to borrow tokens for margin trading, the liquidity pool may be a useful source. If you already have some crypto tokens sitting idle in your wallet, Yield Farming also opens up the possibility of passive income. The amount of rewards you earn from Yield Farming is not precisely calculable, though.
How Does Yield Farming Work?
Before you explore the different steps involved in Yield Farming, you should understand the various entities involved.
First and foremost is the user who deposits the cryptocurrencies in the smart contract. That user is called Liquidity Provider, while the smart contract is called Liquidity Pool. The protocol designs the smart contract rules, and the same rules will decide how much returns you would receive from Yield Farming. Other users may use the Liquidity Pool as a source of tokens for margin trading. However, in the end, everything is controlled via the smart contract.
Getting Started With Yield Farming
- As the Liquidity Provider, you deposit the desired amount of funds into Yield Farming's smart contract. In most cases, these funds will be stablecoins pegged against the United States Dollar (USD). Some of the options are USDT, USDC, and DAI.
- These funds are locked by the smart contract and are available according to the smart contract’s limitations and the Yield Farming platform. Based on how much you have invested, a Yield Farming project will provide you with returns accordingly.
- Returns from a Yield Farming project will be in the form of the cryptocurrency you have already deposited. However, in some cases, Yield Farming also provides users with access to a few tokens that are not listed in the open market just yet.
After you get started with Yield Farming, you might want to focus on some stability by choosing a reputed Yield Farming project with sustainable profits and a robust back-end.
Nevertheless, the Liquidity Provider has the freedom to create intricate patterns of Yield Farming designs. It is possible to invest the rewards from one Yield Farming project in another smart contract and so on. It will help the LP in diversifying their cryptocurrency asset portfolio.
Depending on how quickly you resell the rewards from Yield Farming, you can generate a considerable amount of profit.
Employing a proper strategy will ensure that you have maximum benefits from yield farming. Even when you get rewards in the form of the cryptocurrency you had invested in the first place, there are possibilities to earn better.
The Risks of Yield Farming
Here are some of the common risks of Yield Farming.
- Bugs in smart contracts can impact the stability of rewards you may receive from the project. In some cases, the problems in smart contracts will alter the calculation of rewards.
- If the Yield Farming project is not correctly audited and patched for bugs, it could cause the loss of funds.
In the DeFi environment, everything is connected, including smart contracts. It means the problems in one blockchain network, like network delays and verification issues, may have an impact on your investments and returns.
The Bottom Line
That said, Yield Farming is not entirely risk-free. But as long as you choose a project that suits all your requirements, you have nothing to worry about. Yield farming is also not some magically profitable process. If you know how to analyze the market and invest, Yield Farming may provide you with some great returns. Once you consider all of these factors, you can expand your crypto asset portfolio without much trouble.
By the way, if you are interested in cryptocurrency investments, feel free to create a free account on Liquid and enjoy access to over 80 cryptocurrencies and simple purchases with your VISA card.