Why Is Yield Farming Hot and Trendy Today?
In the crypto world, the terms “decentralized finance” and “yield farming” have become buzzwords. As the technology’s multiple advantages become more apparent, interest in it continues to grow. DeFi, as we call it, is one of the blockchain inventions that is transforming the industry. The fact that DeFi applications are permissionless and trustless is one of the reasons for their growing popularity. To interact with DeFi applications such as smart contracts, all you need is a wallet and an internet connection. Before engaging with decentralized applications, you don’t even need to trust an intermediary or custodian.
What is Yield Farming and How Does It Work?
Yield farming is just a way to make more money with your cryptocurrency. It entails a straightforward method of staking your cryptocurrency in exchange for incentives. If you hear the words “liquidity mining” from members of the community, they’re referring to yield farming as well. Liquidity providers who will push funds into liquidity pools are required for yield farming to work.
A liquidity pool is nothing more than a smart contract with money in it. Liquidity providers who give these funds are compensated for their efforts. Their awards are usually derived from the fees generated by the DeFi platform associated with the pool. LPs may receive their rewards from a variety of sources. Liquidity providers may receive their incentives in a variety of tokens and reinvest them in other pools to generate more rewards. That’s why, when you analyze the tactics used by liquidity providers to earn rewards, Yield farming can appear difficult.
ERC-20 tokens based on Ethereum are used to facilitate the yield farming concept. Yield farmers are also compensated in ERC-20 tokens. This is because DeFi was developed on Ethereum, and the majority of its activities take place within its ecosystem. Although some experts believe that the future may be different, yield farming is now done with Ethereum ERC20 tokens.
What sparked the rise of Yield Farming?
The increase in yield farming can be attributed to supply and demand. When a new DeFi project launches, it will either provide new tokens or provide numerous options for users to earn incentives. When this occurs, every user will flock to the new project in the hopes of earning some benefits, resulting in a strong demand for it. With such great demand, the value of the project and token that developers invested in will skyrocket.
In addition, the introduction of the COMP Token enhanced the appeal of yield farming. Compound Finance has developed its governance token, which allows all holders to participate in ecosystem decision-making. They employed the liquidity incentives strategy to entice LPs in order to distribute money in a decentralized manner. These liquidity providers now supply liquidity to the pool by earning incentives by cultivating the new token.
The Yield farming concept did not begin with the advent of COMP. However, it was critical in popularising the practice. Other decentralized finance projects are now using the Compound Finance technique to construct their liquidity schemes.
What metrics do projects use to evaluate their yield farming efforts?
Total Value Locked (TVL) is the most basic indicator of farming success (TVL). The total dollar value of tokens locked in decentralized finance, both in lending and other money markets, is measured in TVL. Total Value Locked can be thought of as the value of liquidity across all liquidity pools.
The usefulness of TVL in yield farming is that it is used by projects to track yield farming and DeFi progress. It also allows participants to compare the market share of various DeFi protocols. It’s simple for players in the ecosystem to locate sites that have more crypto assets, such as ETH and others, using a platform like Defi Pulse.
As a result, you can see that checking the total value locked is one way to tell if a project has a lot of yield farming. If the TVL is high, it indicates that Yield Farming is increasing. TVL can be measured in BTC, ETH, or USD. As a result, the state of decentralized money markets cannot be determined just by US dollars.
How does it work?
The features and terms of operation of each DeFi application vary. As a result, the application’s originality dictates how Yield farming will function on its platform. Yield farming, on the other hand, is based on the activities of liquid suppliers, liquidity pools, and rewards. The yield farming procedure is even comparable to AMM (automated market maker).
Liquidity providers deposit funds into a DeFi application or liquidity pool, which starts the process. Users can borrow, exchange, and even lend their tokens to other holders using the monies they deposit on the site. However, those who utilize the site must pay a fee, which the LPs will get based on the worth of their funds in the pool. When LPs put money into a pool of different tokens, this is what happens.
Apart from the fees, however, there is another option for liquidity providers to profit from their investment. It could take the form of obtaining a large quantity of newly issued tokens. LPs can offer liquidity to a new DeFi application and amass a large number of tokens, especially if they can’t get the value they want on the open market. As a result, they can rely on yield farming to obtain the desired token.
How are Yield Farming returns calculated?
Annually, yield farming returns are calculated. As a result, as a farmer, you may get an estimate of the profits you can expect over the course of a year. APR and APY are two common computational metrics for calculating returns (Annual Percentage Rate and Annual Percentage Yield).
APR: The annual rate of return imposed on borrowers to compensate capital investors is known as the APR. Borrowers are charged these rates, but the developers use them to pay their capital backers.
APY: This is the annual rate of return that is imposed on capital borrowers but paid to capital suppliers.
As a result, APR prohibits the reinvestment of interest in the scheme in order to increase earnings. However, APY allows investors to earn compound interest.
Yield Farming’s Advantages
Profit is the most important benefit of Yield Farming. Farmers who are quick to farm in a new DeFi project will be rewarded with a high number of tokens. They can sell the tokens for a profit once the value of the tokens rises. They can choose to reinvest their gains in another project for a higher return after they’ve made their profits. Yield farmers, on the other hand, typically invest a large portion of their initial money in DeFi initiatives in order to make a profit. A farmer may have to invest hundreds of thousands of dollars to achieve a significant profit. The danger of yield farming is precisely this.
Risk Involvement in DeFi Yield Farming
Smart contract code is another risk that yield producers confront. Many low-budget entrepreneurs and developers are attempting to reap the benefits of decentralized finance. They sometimes utilize unaudited smart contract codes that are easy targets for flaws due to their zeal. Even protocols with larger budgets are sometimes found to have flaws after being audited by credible firms. These flaws are generally exploited by hackers, who steal millions of dollars by exploiting the gaps.
Is Yield Farming a Difficult Business?
Many decentralized banking systems are built on Ethereum, which has resulted in many of the problems that farmers have faced recently. The growing popularity of yield farming has drawn more farmers to the Ethereum network. As a result, the network has seen an increase in transaction volume. The network, however, is unable to perform these transactions as quickly as it should due to scalability concerns.
Yield Farming Protocols and Platforms
Uniswap
This protocol is a component of DeFi exchanges, which allow users to trade tokens. These simple token swaps assist yield farmers in carrying out their plans. LPs start a market on Uniswap by depositing two tokens with the same value. They create a liquidity pool for traders to trade in by doing so. Meanwhile, the fees on trades in the pool would be used to compensate the liquidity providers.
Compound Finance
This is one of the most well-known DeFi protocols for earning incentives for yield farming. It enables users to do loan and borrowing transactions more easily. To qualify for reward farming on the Compound Finance platform, all you need is an Ethereum wallet. You’ll get incentives as soon as you contribute assets to the liquidity pool, and they’ll start compounding immediately.
MakerDAO
This is a credit network that assists farmers in earning rewards through yield farming. Yield producers can mint DAI and use it in their tactics thanks to Maker. In general, under the MakerDAO system, an individual can store collateral assets such as USDC, ETH, WBTC, or BAT in a Maker Vault and subsequently create DAI against the collateral. However, this loan will accrue interest over time, called the “stability charge,” and the interest rate is normally decided by MKR token holders.
Conclusion
We’ve attempted to make the Yield Farming concept as simple as possible so you can understand how everything works. We’ve also talked about the advantages and disadvantages of it. It’s important to remember that the cryptocurrency market is quite volatile. You can make a lot of money today and then lose it the next day. Even with the given measurements, it’s difficult to provide a reliable forecast of yield agricultural return.
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