There is no need to run out for your pitchfork just yet. This type of farming doesn’t quite require that. When it comes to cryptocurrency, yield farming is more about making income, preferably with minimum effort.
We’ll break down what this technique entails and how yield farming can help you make more with your crypto. You’ll be donning virtual overalls in no time!
Table of Contents
Defining Yield Farming
It is often easiest to understand something when you can compare it, even roughly, to something you already understand. If you are far more familiar with traditional banking and its processes, yield farming is closest in comparison to a bank’s annual percentage yield.
In the more traditional financial models, an investor can earn money when leaving deposits in the bank. This money earns a rate, preset by the terms of the account, just for sitting still.
Earning Interest Like an Annual Percentage Yield
Likewise, your cryptocurrency equivalent would be yield farming. When you invest in yield farming, your goal is to have the value of your crypto increase. In simple terms, when you invest your crypto via yield farming, you are allowing it to earn you fees by lending it through a smart contract to other users.
Returning to the traditional banking style, when you borrow money from a bank, you are, of course, going to pay transaction fees. Some may be upfront costs, established to cover the expenses of say a credit check, a human to research your accounts, and someone to of course to crunch numbers to not only determine what you can borrow, but how much you should pay for the privilege.
No matter how stellar your credit score is, you are certainly going to minimally pay interest rates. That rate will also defray the costs of the banking business, not to mention (they hope) make them a profit, too, allowing them to continue operations.
Yield farmers are using this same concept to earn money back on their crypto, which is sitting in designated accounts.
The Decentralized Exchange
As you may know, crypto marketing, and in turn, crypto yield farming, revolves around the use of the blockchain. The blockchain is a decentralized, public ledger that allows a peer-to-peer (P2P) network to verify and record transactions through the exchange.
This tech makes one of the core pillars of crypto possible. It eliminates the necessity of a central authority. Instead of being overseen by a bank or government, cryptocurrency is not operated via a centralized power.
Security, transparency, and privacy are all made possible via the decentralized finance system of crypto. It also plays a crucial role in yield farming.
Our Powers Combined …
When you factor in decentralized finance (DeFi for short) with the core values of the crypto-sphere, it isn’t hard to see how the system works. By taking out the middle man, or the central authoritative powers that be, the crypto markets allow for people to do buying, selling, and trading more directly.
This peer-to-peer availability puts investors in contact with lenders and makes lending directly from one user to another possible.
Typically, when one needs to borrow funds, raise capital for a start-up, or even purchase a car or house, the world was stuck seeking those funds from the traditional banking institution. Access was limited. There are countless biases. Opportunities and availability can be scare.
But, with the use of DeFi, Average Joe can decide how to share his crypto. He can become one of the investors. He can get into lending and make more money by doing so. He can be the proverbial bank in our traditional model, and he doesn’t have to be rich to do so.
No Reward Without Risk: The Rule of Digital Assets
Of course, these additional freedoms and perks come with risks. What money venture doesn’t, right? The general rule of thumb, which certainly applies to crypto investors, is that with greater risk, comes greater reward.
However, it is important for you to remember that the flip side of that coin is also true. Without the centralized banking system, the backing of a traditional dollar and its value, or the legal support equal to a national chain of banks, the individual lender is taking all that on himself.
While there are safety measures in place, the crypto market can be a volatile and unpredictable beast.
One of the safety features that protect both the lender and the borrower comes in the form of smart contracts. Smart contracts are programmed, automatic processes that run on an “If/Then” concept. If X occurs, then Y is made possible.
Clarify Terms for All
For example, a lender may accept a smart contract available on most platform exchange networks. These contracts will have terms already outlined for both parties. Much of the legal work and fine print is done for you, and all users involved can understand and participate in the exchange with clear and transparent processes explained for them.
Automation Makes the World Go ‘Round
Not only does a smart contract give an outline of terms, but it also provides for automation to the process. If Joe Borrower needs 10 tokens and meets all “if” required statements, then Jane Lender can release the funds without any actual interaction required on her part. This process is automated by the smart contract.
This feature also allows yield farming to be a passive form of income. Once smart contracts are in place, users do not need to do much else. If parameters are met, then funds are released. Buttons are not needed. Oversight is not needed.
The exchange cannot take place unless the “If” occurs, and that means it is forced to be accurate. A computer doesn’t have a bias. It only knows that if the proper “If” is entered, the proper Y is then released.
Not as Simple as It Sounds
While attempting to break down yield farming into its simplest terms, it may start to sound like an easy investment strategy. However, it should be clear that successful yield farmers put in a lot of their own research, and are constantly moving funds.
It’s a Secret
To further complicate things, when someone finds a great trick of the trade, you can bet they aren’t sharing it out there on the Internet especially. If you have found a successful way to yield farm, you are not likely to want others to know about it.
Why? Other users are your competition. If you want to successfully compete in the crypto assets yield farming protocol, you want to have methods you keep to yourself. More competitors mean you will have less revenue, so sharing your business practices with others hurts your own profits.
Using Different Marketplaces
One of the key components of yield farmers do typically know and share is that to make money, you have to move money. Yield farming is not as simple as parking your money in your account and walking away. One of the most crucial actions a potential yield farmer can take is to move money constantly.
Being focused on market trends, ever-changing values, and which sites have the best yield potentials is a huge part of staying attuned to the process, making you all the better of a yield farmer.
Liquidity Pools and Providers
Those that provide funds for a business to be in operation are known in the crypto space as “liquidity providers.” They are staking crypto assets that allow for the functions of the decentralized financial network to operate.
Liquidity providers take tokens and place them in a liquidity pool. Liquidity pools are simply the virtual “pile of funding” the LPs have gathered and staked into a locked state. This is also sometimes referred to as the staking pool.
Why would investors put up money to earn money? They are offered a reward. In short, by posting the money to the pool, users are rewarded a fee or interest.
That interest is generated from the underlying DeFi platform on which the liquidity pool “resides.” Or in other words, the fees paid to the DeFi network are then split amongst LPs that contributed to the liquidity pool.
This process, of LPs pooling funds and being rewarded for their efforts, is all made possible through the dApp, or decentralized application. Liquidity providers made funding possible for the dApp to function, and are in turn earning money for doing so.
The smart contract automates that dApp, again to streamline the process, reduce errors, allow for anonymity, and increase security among its users. Liquidity providers provide the funds to keep the lights on, so to speak, and for doing so are paid via the funds raised by the app through transaction fees.
A (Hope For) a Continuing Cycle
Both borrowers and lenders are often rewarded in different ways on a crypto exchange site. Some sites even have unique crypto for rewards. Users can typically reinvest that bonus or exchange it for cash value.
In doing these sorts of bonus incentives, the market is hoping that it will attract more users. Some may even give out comp tokens, which can seem counterintuitive.
However, more users, means there is more capital (more LPs = more money) to use, more coins to lend, and more borrowers can access funds.
This incentivization creates a cycle or aims to minimize, to keep the marketplace going, and liquidity incentives are one way you can yield funds.
The Risks of Yield Farming
If you only know the absolute basics of crypto assets, you probably already know that one of the biggest risks of any cryptocurrency marketplace is volatility. Yield farming is no different. The number one challenge is, and likely for the long run will be, that the crypto space suffers from very high highs and very low lows.
A vast majority of those new to the scene are not prepared to withstand these drastic changes in value. Crypto exchanges can be a wild ride, and it is necessary to prepare yourself and be realistic about these changes that can happen 24/7.
What Can You Afford to Lose
Knowing that the risks are high, one of the first questions to address if you are considering yield farming seems like an obvious one but is a necessary step when considering any investment strategy, especially one with such a high-risk factor.
Yes, rewards can be great. Earning more crypto can be awesome. But, losing that digital asset is just as realistic of a scenario.
Remember, with Yield Farming, you must first become a liquidity provider. By providing liquidity, your funds are typically in a total locked state. This means, for your predetermined and agreed upon terms, you have said you will allow your funds to stay put, living in the liquidity pools.
Being a liquidity provider is a risk in and of itself. Futures for any crypto marketplace can come and go in the blink of an eye, and that may mean even your initially staked funds given to the liquidity pool can be at risk.
Being One of the Early Adopters
Remember that greater risk, greater reward statement we discussed earlier? Yes, that comes back into play when you consider being a liquidity provider and diving into yield farming. Marketplaces that offer such perks likely are doing so for one reason: they need the funds to keep the marketplace functioning.
A Good Thing or Bad?
While this isn’t per se a bad thing, (meaning who doesn’t need money, and everyone needs to keep the lights on, right?) and every platform deserve to make money (especially enough to keep functioning), one of the basic needs may just be capital to function.
By getting in on a marketplace early, you stand to benefit from the long-term, greatest reward. It is like being one of the founders (however, please note providing liquidity does not entitle LPs to ownership or voting privileges in most cases)!
Always Two Sides To Any Coin
However, the flip side of that proverbial coin is that there is also an enormous risk of diving into something that is untested. Think of it as becoming a test dummy for a new car.
Do you really want to be the guinea pig on which these tests are conducted? Do you want your digital assets to be?
How Much Do You Know?
While a pillar of the cryptocurrency concept is of course to be transparent, yield farming is a strange exception to the open, and often helpful, network of crypto users.
Yield Farmers Keep Mum
As we mentioned, no one wants increased competition when trying to make a buck, so successful yield farming projects are often not discussed. Think of it like the tricks to the trade. They don’t want those secrets released, because then you will become another lender, taking away transaction fees they could be earning on instead.
A Concept in Its Infancy
Another hurdle in an industry still so young is that investors can struggle to truly understand the ins and outs of crypto in general, forget a specific (especially if brand new) platform. To add to that, the concept of yield farming is even newer than crypto itself.
No matter its age, it can be hard to do research and truly grasp the ins and outs of the specific crypto you are thinking of backing. There is a lot of change out there. There is a lot of incorrect information.
You need to know what sources are driven by research and fact and what trends can truly be trusted. There are many out there accidentally misleading readers. Others are more malicious in their efforts.
No matter the goal, there are plenty of problematic and incorrect statements out there. Be sure you find your trusted sources, and learn as much about yield farming as possible.
How much do you know about its history, its blockchain, the technology, the smart contracts, the fine print? How much can you learn? Beyond the understanding of basic concepts, a level of comprehension is required on specific crypto when you are investing.
Constant Change Is Hard to Follow
To add another layer to the challenge, a key component of yield farming, at least in order to have success, is to constantly move funds, hop marketplaces, and adapt and change with the trends. Keeping track of all of that requires time, patience, and a whole lot of research. Do you have what it takes to devote that type of effort?
Is Time on Your Side?
Another risk with taking on yield farming is that, in order to have success, you will need to allow funds to sit tight for some time. Interest rates are not earned overnight.
Moving But Holding Still
While the movement of funds and following market trends is wise, income is made by allowing money to be used by others.
This yielding doesn’t happen unless the funds are “parked” (again often in a locked state for a set term). By becoming investors, users are lending their own assets. They are providing the necessary liquidity by posting their own coins, all so the market can keep running.
But can you afford to leave those coins to sit? Are you earning coins and truly seeing a worth yield? Could your pool of tokens be making more elsewhere?
The Longevity of the Crypto
Additionally, to last long enough to earn rewards in the form of interest payments (or transaction fees), the crypto has to last. Is this particular crypto going to stick around long enough to see your yield paid? Yield farming will only work if it lasts for your loans to be paid back.
What Does Yield Farming’s Future Hold?
It is important to note that no one can see the future. If we could, this entire concept of investment strategy, coins, and lending would really be out the window entirely.
It’s a Brave New World
Still, thus far in the oh-so-young world of crypto assets, it has done well for many seeking to earn rewards by lending funds to others. You don’t have to be the world’s largest bank to see the rewards of interest. It can be paid to you directly through the tokens of decentralized financial markets, operating on peer-to-peer blockchains, maximizing returns for you over time.
It can also mean risking your digital assets, lending over your limits, and “losing the farm” so to speak. Remember to always do your research, understand the risks, and learn as much as you can about any strategy before jumping into it.
Learn the Ins and Outs
Yield farms are no different. Be sure you know what you are getting into when you provide liquidity. Be sure you research the potential to earn interest. Try to know all there is to know about the tokens and coins and the market with which you intend to work with for this endeavor.
Knowledge is never a bad thing, and while it can be tough to obtain, it will benefit you and your farming attempts. Look what you’ve already learned, and it didn’t even require a tractor.