Grab your hat, overalls, and a hoe because we’re goin’ yield farming! Yeehawwww!
What exactly are we growin’ in this big ol’ DeFi field? Why we’ll be growin’ some sweet crypto tokens y’all!
Don’t actually go to your garage and start grabbing farming equipment (you can get changed now, Brian)…we’re going to be having a discussion about a different type of farming: yield farming.
You don’t need to be an agricultural wiz to understand this concept, as yield farming is related to growing your crypto. So if you want to learn how to harvest some sweet stalks of crypto through interest rates, then keep on reading.
In this article we’ll discuss:
What is DeFi Yield Farming?
DeFi yield farming is the process of growing a stash of cryptocurrency by providing liquidity on DeFi platforms. In order to provide liquidity, a lender will lock up their cryptocurrency in a liquidity pool, which is a smart contract containing funds.
This lender then becomes what is known as a liquidity provider (LP). In return, the LP will receive interest as thanks for providing the liquidity. This interest can be paid out in the platform’s token or as the same currency provided in the pool.
Sounds pretty simple right? On the surface, yield farming may appear like an easy way to earn extra revenue by simply lending some crypto, but actually, profitable yield farming is quite complex.
How does yield farming work?
To better understand yield farming you must know how liquidity pools operate. Liquidity pools power decentralized exchanges (DEXs), where traders turn to for trading their ETH tokens. These funds needed for trading cannot magically appear from nowhere, so DEXs depend on LPs to provide this supply of tokens.
By creating liquidity through the lending of their cryptos, liquidity providers receive interest off the DeFi platform as a reward. Supported cryptos typically include stable coins (DAI, USDT, USDC) and ERC20 tokens. An LP will need to lock up the token(s) of their choice in order to start earning interest.
Eventually, the LP will look to move their funds from one DEX platform to another to chase a higher yield. LPs are always keeping an eye on several DEXs to find the best returns possible. Once they spot a DEX that offers a higher APY on their liquidity pool, they’ll withdraw their funds from the current DEX and move it to the new one.
This process allows the LP to maximize their yearly returns by continuously “growing” the funds they contribute to liquidity pools.
What problem does yield farming solve?
Since DeFi is still in its infancy, DEXs are in dire need of liquidity for traders on their platform.
Unlike centralized exchanges, decentralized exchanges cannot provide liquidity as freely for their users. Newer tokens that are not on the open market or have a low volume also face liquidity problems.
Both of these situations provide opportunities for LPs to capitalize on.
If a lack of liquidity exists, then traders are prevented from actively conducting trades and transactions on decentralized exchanges or suffering massive slippage. By LPs putting in a large number of cryptos into liquidity pools, investors can easily get the asset they want on a decentralized platform, while the LP receives a lucrative income, creating a win:win.
While the LP helps the DEX by providing liquidity for their user base to trade with, the LP receives interest from the DEX on the funds they locked up. In the end, LPs and DEXs help each other!
How can you start yield farming?
So you’ve decided you’re ready to start yield farming, so hop on your tractor, and let’s go through some basic things you’ll need.
You’ll want to obtain an ETH wallet if you haven’t already. A great choice would be Metmask since it’s one of the most commonly used ETH wallets (and also works with UpBots!).
DEXs are where you’ll need to go in order to provide liquidity. Uniswap, SushiSwap, Curve, and Aave are some of the more popular DEXs right now.
Once you have the DEX and wallet sorted then check out the liquidity pools on the chosen platform and choose the cryptos you wish to supply.
What to be careful of
Yield farming seems like an easy way to grow and harvest crypto profits right? Well, while it may appear easy on the outside, yield farming isn’t short of risks that may impact your capital.
First off, you’ll need to be wary of the stability of smart contracts you’re dealing with. Many DeFi platforms have small teams, meaning that there aren’t enough coders onboard to fully assess the quality of the smart contracts for their liquidity pool.
If there are bugs and data leaks within the contract, it could lead to exploits from hackers or transaction errors resulting in all an LP’s funds going bye-bye. Before providing liquidity, it’s always a good idea to do research into potential issues/bugs that a platform’s smart contracts may have previously experienced.
Another significant risk to LPs is a crypto coin losing its value. Let’s say you want to provide liquidity on Uniswap using a YFI/ETH pair. Since Uniswap requires LPs to lock funds up in pairs, a change in price of one crypto can affect the other.
The next morning you wake up to discover ETH lost more than half its value! This would result in a massive reduction in your overall APY for that pair since now your ETH is only worth half of what it was initially.
Another very real danger is the Rug Pull. A scam where the founders of the defi solution extract the value of the Liquidity Pool as an exit scam. It’s important to be sure you can trust the project before you invest and of course as is always the case with these very high risk/reward investments, never invest more than you can afford to lose.
That way if you get rekt it doesn’t ruin your life.
What makes yield farming awesome?
Yield farming brings to the table the efficiency of earning high-yielding interest rates all without having to be chained to a minimum lockup period. LPs can start earning interest right away and can unlock and transfer their funds at will.
The decentralized nature of DeFi has allowed yield farmers to not go through any KYC process or other necessary paperwork banks or other CEXs may require. All someone needs are the funds, an internet connection, and the desire to earn interest on their crypto.
DEXs also allow LPs to earn interest on a vast amount of crypto tokens, providing them with more choices. It’s certainly exciting to see multiple token options and APY rates when browsing DEXs.
Lastly, if you are not happy with the interest rates with one exchange, (so long as you don’t mind paying high GAS fees) you can quickly withdraw your funds and transfer them to another. This is another example of how there are a vast amount of choices for LPs when yield farming.
The wrap up
Yield farming is the process of capturing high-yield interest rates in liquidity pools with the goal of maximizing APY returns.
When a lender locks up funds in a liquidity pool they are known as a Liquidity Provider.
Liquidity pools are what power DeFi platforms such as decentralized exchanges (DEXs).
For providing liquidity on decentralized platforms, LPs receive interest rates in return for keeping their funds in the pool.
LPs will scout different DEXs for the highest returning liquidity pools and shift funds around accordingly to maximize their yearly returns.
There’s a vast assortment of options for available cryptos, APY rates, and DEXs available to those looking to start yield farming.
To get started with yield farming you’ll need an ETH wallet (Metamask) and DEX (Uniswap, Sushiswap, Curve, Aave) to provide liquidity on.
While yield farming does carry risks, it can be a great way to make a profit in crypto, especially for those with an abundance of capital.
Are you ready to head out to the DeFi fields and start yield farming? Come join the UpBots Telegram because coming very soon we’re going to have a governance token drop.
It will occur at the beginning of our DAO transition for UBXT holders and afterwards, we’ll have a sweet yield farming opportunity for you to consider.
However even today, UpBots also helps you easily monitor all your capital in liquidity pools with our decentralized assets portfolio monitor. Try out our ETH portfolio monitoring with our free MVP demo.
And now a meme from our community….