Yield farming is when somebody lends their crypto with a purpose to make a revenue from the curiosity rewards. It’s referred to as farming as a result of you are attempting (farming) to get the very best reward charge as potential, i.e. highest yield charge. Yield farmers will hop between lending swimming pools to get the best reward charge. Bear in mind reward charges are usually based mostly on how many individuals are within the pool, so yield farmers will attempt to maintain transferring between swimming pools with a purpose to get the best charges.
Simplified rationalization:
Yield farming: discovering the very best place to retailer your crypto which is able to earn you the best yields.
AKA farming (discovering) the very best place to maximise yield. = farming yield.
Yield farming is multifaceted compromising of a number of methods/subtypes to make maximize your return on crypto investments. These embrace:
1. Liquidity provision
Present liquidity to a liquidity pool via depositing tokens into the pool and obtained returns via buying and selling charges on the liquidity pool.
Instance:
You place $500 of ETH and $500 of BAT right into a pool, your buddy does the identical now there may be $2000 within the liquidity pool.$150 of buying and selling charges from folks buying and selling all day lengthy, I earn $75 since I offered 50% of that liquidity to the pool.As extra folks contribute in direction of the liquidity pool, your reduce of the buying and selling charges turns into much less and fewer. HOWEVER, the worth of the belongings within the pool is secure, as it’s going to require more cash to maneuver the ratios of the belongings within the pool. So if the full worth of belongings within the liquidity pool was $2000 ($1000 ETH + $1000 BAT) and somebody got here in and spent $500 to purchase some ETH and change it for BAT, that might elevate the worth of ETH lots in comparison with if the full worth of the liquidity pool was $5,000,000.
2. Lending & Borrowing
Lending: lend crypto belongings via a decentralised platform to earn curiosity like in regular finance. E.g. Aave, Compound
Leveraged Lending: technique used to extend return on funding via borrowing and reinvesting.
Right here’s the way it works:
Lend cryptocurrencies to platforms corresponding to Compound or Aave.Deposit $100 price of Fundamental Consideration Token (BAT) into Aave. Aave will will let you borrow towards your deposit, say as much as $60, however in one other cryptocurrency referred to as DAI.Your deposited BAT is incomes an curiosity of 30% APR.You change your $60 in DAI for BAT and now deposit that $60 price of BAT, so that you are actually incomes an curiosity of 30% on $160 price of BAT, as a substitute of $100 price of BAT.
Abstract: you deposit $100 price of crypto corresponding to BAT right into a DEX, and the DEX means that you can borrow towards your deposit, so they provide you $60 price of one other token corresponding to DAI, and also you change this $60 of DAT change it for $60 of BAT after which deposit this new BAT into the identical DEX, now you might be incomes curiosity on $160 of BAT relatively than $100 of BAT.
Borrowing: Borrow crypto belongings via over-collateralization of your present digital belongings.
Right here’s an instance for instance how borrowing works in DeFi:
In an effort to have the proper to borrow funds, you need to first deposit collateral. DeFi loans, are usually overcollateralized, all this implies is that it’s important to put more cash in as collateral than what you need to borrow.As an illustration, you need to borrow $1000 of USDC, however you might must deposit $1500 price of ETH as collateral.The rationale overcollateralization is crucial in DeFi is as a result of there aren’t any intermediaries to make sure that you’ll obtain your funds within the case of fraudulent occasions. Overcollateralization ensures that the creditor is not going to fall sufferer to fraud, as performing fraud on the debtor facet, simply would not make financial sense.
3. Staking
Staking is technically a type of yield farming as a result of you should purchase cash, stake them, after which earn extra free cash.
For instance with Tezos, in 2021 you had a 6% APY, however it’s important to have the {hardware} and data to arrange your individual staking node that might be dependable all year long. However if you wish to keep away from this trouble, you’ll be able to go to a platform corresponding to Coinbase, which stakes for you, however they take a reduce of your 6% APY
4. Holding cash which have a redistribution payment
You need to maintain cash which have the potential to extend in worth. Most individuals put money into cash and tokens which have viability based mostly on their use case potential, the crew engaged on it, the tokenomics, and many others.
However one other aspect to take a look at is to put money into cash which have a redistribution payment.
Some cryptocurrencies like Safemoon, cost a payment on transactions e.g. 10% transaction payment, this payment shouldn’t be misplaced however utilized in methods that may profit the remaining holders of the cryptocurrency. 5% is burned ceaselessly, and the opposite 5% is redistributed evenly to all different holders. The concept behind that is that the 5% of burned Safemoon, reduces the provision and may in principle improve the worth (if demand stays fixed). So simply by holding the coin Safemoon, you’ll earn free Safemoon via everybody else’s transactions.
Instance:
There’s a complete provide of 1000 Safemoon cash. A transaction of 100 safemoon happens with a ten% transaction payment:
-5% Burned:
· Transaction quantity: 100 cash.
· Burned: 5% of 100= 5 cash.
· Impact on Whole Provide: complete provide of Safemoon decreases by 5 cash from 1000 to 995.
-5% Redistributed :
· Redistribution: 5% of 100 = 5 cash
· Your share: because you personal 10% of the full provide (100 out of 1000 cash), you get 10% of the 5 redistributed cash = 0.5 cash
After the transaction:
· Your New Holdings: 100 (preliminary) + 0.5 (redistributed)= 100.5 safemoon cash
· New complete provide: 995 Safemoon cash (after burning 5 cash).
Abstract:
After this single transaction state of affairs, I now have 100.5 safemoon cash, and the full provide of safemoon cash in circulation has been diminished to 995 cash.
5. Auto-compounding
PancakeBunny is a platform that optimises your earnings or yields from investments made on PancakeSwap, which is a decentralised change. Whenever you put money into their token, PancakeBunny affords rewards. With the “auto-compounding” characteristic, PancakeBunny takes any rewards you earn and robotically reinvests them for you, thus boosting your funding development with out you having to manually reinvest your earnings.
Instance for instance auto-compounding:
Think about you make investments $1000 in Pancake Bunny’s token, and also you earn 10% rewards after a month, which might be $100. With Auto-Compounding:
1) As a substitute of taking that $100 reward out, PancakeBunny robotically provides it again to your preliminary funding. So now your funding is $1100.
2) The following time rewards are calculated, they’re based mostly on this quantity ($1100), not the unique $1000. Should you earn one other 10% reward, that’s $110 this time, not simply $100.
3) This course of repeats, with every spherical of rewards being added to the final, inflicting your funding to develop extra rapidly over time since you’re incomes rewards on prime of rewards.
Dangers of Yield Farming
Rug Pulls: when builders pull out of a projectImpermanent loss: when the worth of 1 token vastly adjustments in comparison with the opposite token
Degen Yield Farms
Degen yield farms contain lending your cryptocurrency/ offering liquidity to a less-established (degenerate) DeFi mission, with the possibility of receiving rewards within the type of new tokens.
They’re high-risk, high-reward investments, as they provide larger yields but in addition a larger danger on the funding.
What are the dangers?
Hacks. The initiatives are untested so they could be weak to hacks. And you might run the danger of the rewards you obtain being nugatory.
Insurance coverage
With automotive insurance coverage you pay $100 a month to guard your automotive, if you happen to get into an accident, the automotive insurance coverage firm pays you what your automotive is price and so they use statistics to foretell the worth of their insurance coverage monthly by analysing what number of of their drivers will crash their vehicles and makes use of this information to foretell how a lot they must pay out annually to find out what the month-to-month value of the insurance coverage is (insurance coverage premium).
With DeFi, the insurance coverage is CODE, so within the good contract you may have a chunk of code that claims “Pay farmer Joe £100,000 if it’s 95 levels or hotter 4 days in a row, nonetheless, he has to pay $2000 to provoke his contract”. The good contract makes use of oracles to achieve real-world up-to-date info i.e. to see if it was 95 levels or hotter 4 days in a row.
Stablecoins
Stablecoins are cash whose worth is pegged to the worth of fiat forex. They’re designed to have a secure worth. For instance, the USDC coin is pegged to the US greenback, which means for each 1 USDC in circulation there may be an equal 1 greenback held in reserves.
One other manner stablecoins preserve their worth is thru algorithms. Some stablecoins like DAI will use good contracts to handle their provide. If the worth of DAI begins to rise above a greenback, then the good contract will create extra DAI to carry the worth down. If the worth drops, it’s going to scale back the provision to push the worth again up. That is referred to as REBASING.
Collateral-backed stablecoins are stablecoins backed by different cryptocurrencies. For instance, MakerDAOs DAI entails customers depositing their crypto belongings like ETH into a wise contract as collateral to generate DAI.
