Why Yield Farming is Taking the World by Storm

Jan 6, 2023

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Introduction

What we’ve been noticing

Yield Farming is one of the hottest topics in decentralised finance. There is a high chance you may have already heard something about the insane returns some of the yield farmers are making. If you're looking to increase your returns on your cryptocurrency investments, you may be interested in yield farming. But what is yield farming? How does it work? What are some examples of yield farming? How severe are the risks involved? We’ll walk you through all of this in this article.

But before we start, if you’re a beginner to Decentralised Finance (DeFi) you may want to read our "DeFi Explained: A Beginner's Guide to Understanding and Getting Started" article first.

Key Topics this Article will Cover:

Getting Started: What is Yield Farming?
How does Yield Farming work?
Yield Farming Returns: What you need to know
Why is everyone obsessed with Yield Farming?
Conclusion

Getting Started: What is yield farming?

Yield farming is a method of earning rewards or interest by staking and lending cryptocurrency to DeFi protocols and platforms. Similar to how you'd earn interest on depositing money in a bank, yield farming involves locking up your cryptocurrency, called staking, for a period of time. In exchange for interest or other rewards, such as more cryptocurrency.

How does yield farming work?

In many ways, yield farming works like a savings account, where you deposit money with a bank, which then pools depositor money and lends it forward while you earn interest on the funds you deposited. But instead of being converted into a mortgage, personal loan or business loan, the cryptocurrency in a yield farm is invested in smart contract applications.

Smart contracts are pieces of code that automate financial agreements between two or more parties using blockchain technology.

When people talk about yield farming, they discuss it in terms of annual percentage yield (APY). This often invites a comparison to the interest rate you might earn on a savings account at a bank. And while bank interest rates are extremely low, yield farming can produce APYs in the triple digits in some cases. Though those returns come with considerable risks and are unlikely to last long.

APY is your annual return on an investment that takes into account compound interest that is accrued on top of your initial investment. This means you’ll earn interest on the initial investment, as well as interest earned on that interest.

Yield farming returns: What you need to know

Yield farming can be very profitable if properly executed, with numerous examples of individuals earning sizable gains. However profits come with risk as cryptocurrency are highly volatile assets. Many potential investors may wonder what yield farming strategies are the most profitable and effective. The short answer is, it’s dependent on how much asset and time investment you’re prepared to put into yield farming. Although some high-risk strategies promise significant returns, these often require an in-depth understanding of DeFi platforms, protocols and complex chains of investments to be most effective.

There are several ways to generate yields from your crypto holdings:

Staking tokens on a blockchain
The most common is staking on proof-of-stake blockchains, where a user is paid interest to pledge their tokens to the network to provide security.
Lending
Crypto coin or token holders can lend their cryptocurrencies to borrowers through a smart contract and earn yield from interest paid on the loan.
Becoming a liquidity provider for a decentralised exchange
Providing a pair of crypto tokens in equal amounts to a decentralised exchange allows it to perform trades for investors looking to exchange one cryptocurrency for another. As a liquidity provider, you'll earn a portion of the fees collected by the exchange in return.

Why is everyone obsessed with yield farming?

Interest rates on traditional bank savings accounts remain extremely low. That is why people opt for yield farming because it offers a way for those participating in the decentralised finance ecosystem to generate better returns on their holdings.

Furthermore, using yield farming techniques also strengthens many of the systems used in cryptocurrency and DeFi. This is by improving the blockchain, increasing liquidity through lending, and ensuring decentralised exchanges can perform currency swaps efficiently.

Conclusion

Yield farming involves staking, or locking up, your cryptocurrency in decentralised exchanges for rewards or more crypto. This not only gives crypto investors a unique passive income opportunity but also provides much-needed liquidity to DeFi platforms. While it's possible to earn high returns with yield farming, it is also incredibly risky. That said, with proper trading education venturing into this space is worth the risk. When executed responsibly and properly, it can result in impressive returns.

As a reminder, never invest more than what you can afford to lose and don’t let FOMO get the best of you. There will always be a new protocol promising sky-high annual percentage yields. Do a thorough research before putting your money into anything. If it’s too good to be true, it probably is.

Watch the video below to learn more about yield farming. Don’t forget to like and subscribe so you don’t miss out on important updates and up-to-date videos.

Got a question for our author regarding this article? Contact her at:

Lisa JY Tan | Founder and Managing Director
E: Lisa.T@EconomicsDesign.com | W: EconomicsDesign.com