Crypto Yield Farming: What Is It & How Does It Work? by Sarah Kutu

When people hear of cryptocurrency investing, they automatically think of buying and selling Bitcoin and other digital assets. However, like in traditional finance, many ways exist for people to invest in cryptocurrencies besides active trading. One of the common options is yield farming. 

This investment model allows people to earn passive income from cryptocurrencies by locking them up in liquidity pools for interest. This article explains crypto yield farming in detail to help investors understand how it works, including its benefits and risks. 

What is Yield Farming?

Yield farming is a popular income-generating investment opportunity in the crypto world. It refers to the process of locking up crypto tokens in a liquidity pool or decentralized finance (DeFi) protocol for periodic rewards, which are usually the platform’s utility cryptocurrencies. 

That’s why some call it DeFi yield farming to emphasize the fact that it’s only obtainable in the DeFi space. There are various yield farming crypto methods. The most popular involves investors depositing their assets in a lending protocol or trading pool to provide liquidity. 

For instance, you can join decentralized exchanges (DEXs) like Uniswap, PancakeSwap, or SushiSwap and provide them with liquidity using your assets. That means you are directly supporting the easy flow of assets or transactions across buyers and sellers on the platform. 

Due to their indirect work for the platform, they get rewarded with a certain amount called an annual percentage yield (APY). These returns depend on their investment amount and the liquidity protocol they choose. Let’s look at the other yield farming strategies in the next section. 

Popular Yield Farming Strategies 

Besides liquidity provision on DeFi protocols, other popular crypto yield farming methods among investors are listed below. 

DeFi Lending 

Some DeFi protocols support borrowing and lending as we have in traditional finance. However, instead of borrowing money, they exchange digital assets. However, the assets loaned out to borrowers are made available by lenders, who lock their assets on these platforms for crypto loan purposes only. 

A typical example is locking your crypto holdings in a lending protocol like Compound or Aave so that people can borrow them for trading and other purposes. When these people repay their loans, you get your crypto funds back with interest. 

One advantage of lending is the relative stability it offers. Instead of actively trading against market forces, you can earn stable returns by just putting your money to work. 

Crypto Staking 

Another common yield farming model is crypto staking. This is arguably the most popular form of farming crypto yields among investors. It involves locking up your assets in a protocol to support its operations and security. One reason investors fancy staking is because it is not limited to only DeFi protocols. 

Proof-of-stake (PoS) blockchains like Ethereum, Solana, and Polkadot allow investors to lock up their proprietary tokens like ETH, SOL, and DOT within their networks to support transaction validation. In other cases, you can stake your assets in DeFi protocols and also earn passive income from your investment. 

However, in some cases, staking rewards are paid using the utility token of the platforms you invest in and not the cryptocurrency you staked. Plus, how much staking reward you get is determined by your investment amount. 

Yield Aggregation 

Next up is yield aggregation, which is a more automated yield farming system. While DeFi lending and staking are mostly initiated manually by an investor, yield aggregation is automated to ensure your funds are invested into the most profitable channels in the DeFi market. 

That means you can trust the system to automate the process and prevent stress or manual errors. For instance, if you deposit crypto funds into platforms like Yearn Finance, you give the system the power to use your funds in the best way possible and generate profit for you. 

Dual Asset Farming

As the name suggests, dual-asset farming involves locking two different tokens into a protocol to earn returns from both assets simultaneously. The rewards are paid through transaction fees from the protocol users, but in some cases, the liquidity platform sets aside some tokens to reward investors. 

For instance, you can lock up the ETH/USDT pair in a liquidity pool with the hope of making higher rewards than locking one asset. As such, your risk exposure is high, and so is the potential return. However, if a sudden price gap occurs between both tokens, you’ll experience impermanent loss. 

Benefits of Yield Farming 

Here are some perks of investing in yield farming:

Generate Passive Income

The most obvious essence of yield farming is income generation. It allows you to earn stable gains without doing so much. All you have to do is lock your tokens over a certain period. 

Enjoy High Returns 

The profit margin from yield farming is usually higher than what you’ll find in the conventional financial world. For instance, you’ll find protocols with up to 140% APY. 

Diversification

Yield farming creates a decent way to spread your capital across multiple investments. You can invest in different protocols to balance risk and reward. 

Risks of DeFi Yield Farming

Impermanent Loss 

This kind of loss happens when the prices of your locked token change after providing liquidity or giving loans. In a bid to find a balance, the protocol may automatically sell off some assets, which can result in a loss for you. 

Volatility

Price swings can impact your coin’s value and its associated profits. For instance, if you lock up your coin for six months and its price drops significantly, you lose your accumulated or potential profit. 

Should You Consider Yield Farming? 

Yield farming can be rewarding for investors and it creates an easy way to earn passive income from crypto. However, the most prominent risk is loss of funds due to price volatility and impermanent loss. In other words, you should only invest in yield farming if you have the risk appetite to match the various possibilities. 

Bring Your DeFi Farming Protocol to Life With Zypto

Are you looking to build a DeFi protocol for yield farming and other possibilities? Leverage Zypto’s custom development service to build faster and cheaper. With a team of expert Web3 developers, you don’t need to hire in-house to get your project off the ground. Visit the Zypto website to get started. 

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