If you’re looking for a way to generate passive income, expand cryptocurrency asset portfolio or generate more return on your assets, yield farming might be for you. Available since 2020, yield farming is the process of staking or lending crypto assets to generate high returns or rewards in the form of other crypto currencies. It is a high-risk strategy but with potentially high rewards. Therefore, it’s important to understand how it works before venturing into investing your assets.
We’ve prepared a short guide on yield farming and hope you’ll find it useful and inspiring to start your journey in farming.
First things first, what exactly is yield farming?
If we look at both words separately, ‘yield’ is a financial term, which means the return that a person gets for investing his assets. ‘Farming’ represents the possible exponential growth the investor can receive in case his investment proves profitable. ‘Yield farming’ is, essentially, a method of earning interest (or rewards) by depositing cryptocurrency into a pool. In simpler words, it’s lending funds to others through smart contracts and receiving interest in return.
How does yield farming work?
An investor, or a yield farmer, stakes their cryptocurrency through a dApp (a decentralised application on DeFi). When the funds are in the liquidity pool, other investors can choose to borrow it for their own investments, and in return the original investor receives rewards.
Broadly speaking, yield farming is similar to opening a savings account. A client deposits money with a bank. The deposit becomes part of a bank’s general liquidity pool. And the bank, in turn, take this money to use it further – lend it to other clients or provide to customers. For his investment the client earns interest on the money deposited. Same with yield farming in cryptocurrency, but instead of the funds being converted into a mortgage or a business loan, the deposited cryptocurrency is invested in smart contract applications.
Is yield farming the same as staking?
Yes and no. Staking means depositing cryptocurrency and one earns rewards from holding specific cryptocurrencies. We will discuss staking in future posts, but generally both terms are often used interchangeable, since both are ways of earning rewards on cryptocurrency being deposited in a pool. However, not all methods of staking are yield farming, whereas yield farming always in some way relies on some form of staking.
Pros & Cons:
Undeniably, yield farming has some great advantages. There’s a potential to earn high interest rates, returns being over 100% APY (annual percentage yield). Yield farms are managed by smart contracts, thus removing the middleman and allowing anyone to participate.
But even though yield farming sounds like a great opportunity to make some passive income, as we’ve mentioned before, it’s a highly risky strategy. There are certain negative factors that need to be considered:
- Rug pull is an exit scum, when the founders have no intention of returning to the project. And it happens when the developers or the founders abandon a project and pull the project’s liquidity funded by investors. Investors are left with their coins, but unfortunately, they become worthless.
- Smart contracts can be hacked or there can be bugs, which make the funds vulnerable to being stolen.
- Impermanent loss may happen since while the funds are staked; they still follow their market value. So, it’s possible for an investor to love a lot more than interest received if the staked crypto drops in value.
- Volatility. When one’s crypto is deposited, it may be required to be staked for a specific period. If during this time the staked coin’s value skyrockets or plummets, one cannot do anything about it until the coins are released.
Very well, but how to actually start yield farming?
Since this is a quick overview of yield farming, we won’t go into too many details. But to paint the picture for a general understanding, here are the steps you need to take to start yield farming:
- Research yield farm investments and sign up on a liquidity pool. For example, Aave.
- Connect your wallet or fund your account. To participate in a yield farm, one needs to have a compatible account with the correct currency. For decentralised yield farms you’ll need to participate in a wallet, such as MetaMask and the desired currency needs to be transferred into the account through an exchange.
- Stake your cryptocurrency into the yield farm of your choosing. Once staked, the currency may be locked for a period and you won’t have access to it.
- Collect your earnings. Depending on the farm and the deposit method, the way to collect may vary.
And finally, is it worth it?
Well, as they say, nothing ventured, nothing gained. However, to be successful, one needs to have a working strategy to maximise the yield. Experienced yield farmers use very complicated strategies, they constantly move their cryptos around between different lending marketplaces to maximise the returns. And the strategies are kept secret. So, if you’re prepared to actively work on your passive income, learn in depth how yield farming works and accept the risk, then it’s for you.
And we at Tencoins will continue to bring you more interesting updates about what’s happening out there in the world of cryptocurrency and technology. Stay tuned!