If recent trends in the world of cryptocurrency are anything to go by, the world of decentralized finance (DeFi) is booming.
Although much of its growth might be attributed to a more general interest in the technological and commercial opportunities presented by DeFi and its related technologies, there is one factor that has helped to catalyze the growth of the industry: yield farming.
For would-be investors, yield farming presents an almost irresistible opportunity to generate capital growth using your cryptocurrency portfolio with little extra effort required on your part. But what exactly is yield farming, and why has it helped to generate explosive growth in the world of DeFi?
Yield farming: the basics
At its most basic, yield farming is a way of earning interest on any units of cryptocurrency you own, just like you would earn interest on funds you have in a savings account. In much the same way, yield farming involves locking up (i.e., depositing) your cryptocurrency for a set period of time in exchange for interest or other rewards. This process is called ‘staking’ and is one of the main reasons why DeFi projects have generated such interest in recent months and years.
For investors wanting to use their crypto portfolio to generate an income, the value proposition underlying yield farming is simple: you take cryptocurrency that would otherwise be sitting in storage in a cold or soft wallet and lend it out to generate returns.
The attraction of yield farming was increased by certain projects offering lucrative returns, which were sometimes in the triple digits.
How does yield farming work?
Yield farming works by allowing an investor with a given amount of cryptocurrency to deposit it into a lending protocol through a decentralized app (or dApp).
These dApps offer incentives to users for providing liquidity. This process is facilitated and managed by smart contracts, which are essentially lines of code on the blockchain of that currency.
What risks does yield farming have?
As with any form of investment, yield farming is not risk-free. Some of the most notable risks associated with it include:
- Rug pulls: This happens when a developer gathers investor funds for a project and then abandons it without returning the original investments, leaving the liquidity providers high and dry.
- Fraud: Liquidity providers must do their due diligence to assure themselves that the project they are providing liquidity to is not fraudulent.
- Price volatility: As funds will be locked up for defined periods of time while staking, there is a risk that prices will crash or surge during this time. This might create unrealized gains or losses.
- Regulatory risks: In many jurisdictions, regulatory authorities have been relatively slow to respond to the world of DeFi, while in others they have issued cease and desist orders against certain projects due to breaches of regulations.
What currencies can be used for yield farming?
If you want to start yield farming, you will have to use a lending protocol in order to become a lender or liquidity provider. Popular lending protocols include Compound (COMP) and Aave (AAVE), which can be used to take out loans against crypto assets. Interest is provided to the lender through these protocols. This acts as the reward for staking.
You can also become a liquidity provider for a decentralized exchange such as PancakeSwap or Uniswap. Here, the platform matches liquidity providers with those in need of liquidity, with both the provider and the platform earning a portion of any fees charged and collected.
Yield farming can be undertaken with various different cryptocurrencies, though the most popular coins tend to receive the highest demand. This includes the likes of Ethereum, Litecoin, Monero, Tether, Ripple, Bitcoin and Binance Coin – many of which are usable on VIPCoin Casino!
Is yield farming worth it?
Although you can potentially earn some rewards by yield farming, whether or not it is worth it ultimately depends on your own personal risk profile.
If you are willing to put up with a moderate degree of risk and have done your due diligence to ensure that the projects you are investing in are legit, then you can earn some decent rewards. However, for many novice investors in the cryptocurrency space, your risk profile might be much lower.
The world of DeFi and dApps has opened up many new and exciting investment opportunities for cryptocurrency enthusiasts, of which yield farming is just one. If you do your homework and only invest in projects you understand and trust, yield farming might be a good option for you!