Crypto investing 101: Things to know about yield farming

Crypto investments are becoming a popular trend in the digital sphere due to the ludicrous returns when investing digital assets in well-known exchanges. 

One of the ways to improve your investments is by yield farming your cryptocurrency, which is one of the most well-known investing techniques in the DeFi sphere. What is it and how does it work? How can you start your crypto investing journey by placing minimal capital using the yield farming method? 

Get to know everything about this investment method as you browse through BTC Post!

What is yield farming? 

In banks, there are certain types of accounts where you earn a percentage of interest on the capital by locking your monetary assets and lending them to the institution to earn rewards. 

Yield farming is similar in a way to this type of earning interest. It’s simply a way for you to generate ‘passive income’ across various decentralised finance (DeFi) platforms as other crypto enthusiasts put it. However, there’s nothing passive in lending crypto assets to generate high returns. So how does it work? 

Where it started

Around June of 2020, Ethereum-based credit market Compound started its distribution of COMP to the users. This gave holders unique voting powers for the changes in the platform, which was distributed through liquidity incentives to make the network as decentralised as possible. 

This paved the way for yield farming because it gave users an incentive to lend their assets and earn voting powers in exchange. Since then, the LP structure has been applied to other crypto ecosystems and markets.  

Yield farming crypto: A deeper understanding of how it works

Yield farming is a type of crypto investment that utilises a reward scheme where investors can stake or lend crypto assets to the exchange to earn additional digital coins in the long run. 

The protocol incentivizes liquidity providers when they lock up their assets in a smart-contract based liquidity pool (LP). This means that when you lend your crypto assets, you earn money from a percentage of the transaction fees or interest rates from lenders. 

Other liquidity pools pay rewards in multiple tokens that can be deposited to other liquidity pools. This will give you more opportunities to earn interest in other LPs or pay for the loan and cash out the rewards. 

Returns of yield farming are gauged through the annual percentage yield (APY). This is measured through the estimated returns for the year, hence its name. 

Types of yield farming

Many farmers generate yield farming income in a variety of ways through decentralised exchanges (DEX). These platforms’ algorithms allow users to lend, borrow or stake digital coins to speculate on price swings. 

One of the fastest ways to earn money is to facilitate smart contracts in several DEXs. The several types of yield farming work best when farmers blend the methods for higher rewards. 

Below are the types of yield farming that can be utilised by crypto enthusiasts like you:

Liquidity provider

This allows you to deposit coins to a DEX to provide trading liquidity to a platform and earn from the small fee that’s used to swap the two tokens. This can be paid using new LP tokens. 

Lending 

Users can lend crypto to borrowers through smart contracts to yield money from the interest paid on the loan. 

Borrowing

The tokens or coins that farmers have can be used as collateral for another loan. These can then be used for yielding additional crypto assets so that farmers can keep their initial holding while earning from the borrowed coins. 

Staking

There are two types of DeFi staking. The first one is the proof-of-stake blockchains where the user pays interest to pledge their token to the network. The second type is staking LP tokens. This allows users to earn additional coins from supplying LPs with liquidity. 

Yield farming: Is it risky?

Just like any investment opportunity, yield farming has its sets of risks. This is often magnified because of how volatile the value of each crypto asset is in the market. However, the riskier the investment is, the bigger the returns you can get as an investor if you succeed. 

With its complexities comes risk factors that you should consider before investing so you’ll have educated decisions that won’t affect your assets:

Rug pulls 

This is a type of investor scam where the developer gathers funds from liquidity providers and pulls the plug on the project without returning the money to the users. 

Fraudulent websites

It’s good to know the reputation of the platform you’re using before investing because there are phishing websites that disguise themselves as DEX. These exchanges phish information and steal assets from farmers in the sneakiest ways possible. 

Volatility

There’s no way of knowing whether the coin will go up or go down in the coming weeks, days or even hours. It can be a huge risk to invest in this type of crypto market, especially if you’re only beginning to explore digital assets.

Popular yield farming crypto protocols

Several DEX platforms are available for crypto enthusiasts to yield rewards for crypto assets and tokens. Moreover, for maximum profit, many will use a variety of DeFi exchanges to optimise the returns on staked funds. 

Although there are plenty of platforms available, here are the most popular and top performing ones:

Compound Finance

This is the platform that started it all because it allowed lending and borrowing of assets which created money-making markets for investors. Users earn rewards from algorithmically adjusted interest rates as well as governance tokens called COMP. 

Aave 

For an open-source non-custodial decentralised platform, this is the right choice. It has a lending and borrowing protocol that allows users to earn compound interests for their assets. 

Uniswap 

Almost any ERC20 token pair can be swapped using this platform without any intermediaries. In return for a portion of transaction fees and UNI governance tokens, users must provide a liquidity stake for both sides of the LP. 

Sushiswap 

It’s similar to Uniswap because the platform is its fork. This caused a huge wave in the DeFi community thus creating a new ecosystem with multi-chain Automated Market Maker (AMM) protocol as well as lending and leverage markets. This also supports on-chain mini dApps. 

PancakeSwap

Pancakeswap functions similarly to Uniswap and Sushiswap but instead of running on the Ethereum network, the platform is created on the Binance Smart Chain network. What makes this DEX a lot more interesting is its focus on gamification-focused features allowing for NFT collections in crypto earning games. 

Curve Finance

It is the largest DeFi platform in the community in terms of the number of locked-in assets, meaning there are plenty of coins that can be borrowed for staking. It also has its own market-making algorithm that makes it the perfect exchange for strategic swapping and lending. This is a beneficial platform both for swappers and liquidity suppliers alike.