Crypto Investing
19 Jan 2021

What is Yield Farming & How You Can Profit From It?

Nisha Ramesh

Yield Farming – the name sure sounds like a term that has been pulled out from a farmer’s handbook. But well, it definitely has nothing to do with growing crops or poultry. 

Yield Farming is a relatively new term in the crypto world. For quite a long time, making (or losing) money in crypto was solely based on the speculation of Bitcoin and Ethereum prices. Many people then built software on top of the Ethereum, which acted like banks without bankers. 

This allowed people to take a loan against themselves without any paperwork or ID. And this is how this brilliant innovation called Yield Farming was born. 

Still, confused? Let’s delve deeper into the topic. 

What is Yield Farming?

Yield Farming makes cryptocurrencies using other cryptocurrencies and is a part of the Decentralized Finance (DeFi) network. 

Let me explain: 

A yield farmer lends his cryptocurrency to others through computer programs known as smart contracts. In return for this, they will earn interest or fees in the form of cryptocurrencies. 

In specific, yield farming is the process that allows you to lock up your cryptos holdings in return for rewards.

Such rewards could include a percentage of transaction fees, interest, and/or governance tokens. These incentives are expressed in terms of Annual Percentage Yield (APY). 

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How Does It Yield Farming Work?

The basic functioning of yield farming is just like that of banks.

Banks collect deposits from you and lend that money to borrowers for interest. In return, the bank pays a certain percentage of interest to you.

The same theory applies here, except here, you will be lending your cryptocurrencies. 

Yield farming involves liquidity providers and liquidity pools. Basically, it requires you to deposit funds into liquidity pools, smart contracts containing funds. The pool powers a marketplace that enables users to lend, borrow, or exchange crypto.

Once you have deposited your funds in the liquidity pool, you become a liquidity provider. Liquidity providers are paid out with the fees collected for marketplace usage, considering their share in the pool. 

Other than fees, another incentive granted to liquidity providers could be the distribution of new tokens. For example, you may not be able to buy a token in the crypto market, but you can accumulate it by adding more funds to the pool. 

Simply:

Liquidity providers get returns based on the level of liquidity they provide to the pool.

However, yield farming is not as simple as it sounds. Yield farmers are generally experienced with the Etherium network and technology – they tend to move their funds from one DeFi platform to another to earn the best returns. 

What is Unique About Yield Farming?

The primary advantage of yield farming bluntly is its ability to provide sweet profit.

Suppose you are an early adopter of a project. In that case, you could generate token incentives that might shoot up in value in the future. Selling these tokens at a gigantic premium could earn you significant profits.

Currently, interest from yield farming can be much more lucrative than that provided by traditional banks. 

However, interest rates can be highly volatile. It is difficult to predict what the rewards could look like over a period. Also, there is a certain degree of risk attached to the funds that are kept in DeFi. 

Risks Involved In Yield Farming

Yield Farming is complex and carries significant risks to both lenders and investors. 

  • The highly profitable yield farming strategies are very complex and can be taken advantage of only by experienced users.
  • It requires a lot of capital investment and can be suitable only for crypto giants. If you want to invest small capital, you may incur a net loss from farming.
  • Most notably, it is susceptible to hacks, bugs, and frauds because of the possibility of some vulnerabilities in smart contract protocols.
  • The immutable (unchangeable) nature of Blockchain makes certain DeFi losses permanent and irrecoverable. 

Bottom Line

Wrapping up, Yield Farming can be a lucrative choice for investing your money to earn gigantic profits. But, it remains a somewhat decisive topic in the crypto world. It is not everyone’s cup of tea. 

For now, Yield farming stands to be a high risk, high reward investment. It may be worth exploring, provided that you have carried out adequate research and risk assessments in advance. 

Well, that’s all, Folks!

See ya…

[su_note] KuberVerse is an educational initiative. Anything expressed here directly or indirectly is not investment advice. And we ask you to do your own research before investing. [/su_note]

Disclaimer : Crypto products and NFTs are unregulated and can be highly risky. There may be no regulatory recourse for any loss from such transactions. The information provided in this post is not to be considered as investment/financial advice from CoinSwitch. Any action taken upon the information shall be at user's own risk.

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Nisha Ramesh

Content Writer

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