Key Takeaways
- Yield farming is the means of earning interest in cryptocurrencies.
- With yield farming, crypto token holders can maximize their rewards across various DeFi platforms.
- The best yield farming protocols in DeFi are Curve finance, Aave, and Uniswap.
Yield farming in crypto is just like earning interest on a bank savings account. Technically speaking, earned interest is like lending money to your bank. The same is true for yield farming.
What is yield farming?
As mentioned above, yield farming is similar to depositing money into a bank account. In this case, yield farming is the process of depositing and locking cryptocurrencies on decentralized finance (DeFi) platforms. This involves lending (or staking) the cryptocurrencies (or tokens) in exchange for rewards in the form of an earned interest or transaction fee.
Yield farming has successfully driven growth in the DeFi market – growing from a market cap of $500 million to $10 billion in the year 2020.
How does yield farming maximize returns for its users? Users can either borrow or lend their cryptocurrencies on DeFi platforms and earn more cryptocurrencies for their services. Additionally, users can increase their returns by shifting their cryptos to other DeFi platforms (that provide better returns).
How does yield farming work?
Also referred to as liquidity farming, yield farming works by allowing cryptocurrency holders (or yield farmers) to stake their crypto assets by depositing them through a decentralized app (or dApp). Some examples of dApps are crypto wallets, DEXs, and more.
Yield farmers can use DEXs to lend, borrow, or stake their crypto coins to speculate on crypto price projections and earn interest. For instance, yield farmers can be liquidity providers (or LPs), who store their crypto coins or tokens in a liquidity pool. A liquid pool is a smart contract-based dApp that contains all the funds. Once the LP tokens are locked, LPs are awarded a transaction fee or earned interest generated from the DeFi platform.
In short, what is yield farming in crypto? It is an income opportunity for yield farmers to lend their owned crypto tokens using a dApp.
Why is yield farming so popular?
Yield farming is extremely competitive with rapid changes in incentives. Typically, returns from yield farming are annualized and calculated over the entire year. The two most common methods used to calculate returns are annual percentage rate (or APR) and annual percentage yield (APY). For example, CoinMarketCap runs liquidity pools with double-digit APY annually or some with over 1000% point APYs.
How to reduce risks in yield farming?
Despite its growing popularity, yield farming has its share of financial risks in the form of price fluctuations and impermanent losses. Here are some measures to safeguard your yield farming:
- Invest into yield farming projects from companies that prioritize security and have yearly audits.
- Maintain healthy borrow ratios.
- Reduce all risks in smart contracts by confirming that it has been audited.
- Approach yield farming as a long-term project – for the best returns.
Best yield farming platforms
1. Aave
As a leading yield farming platform with a market value of over $3.4 billion, Aave uses its native AAVE tokens to pay investors interest on their deposits.
2. Curve Finance
The largest DeFi platform with a total value of nearly $19 billion. Curve Finance platform provides yield farmers with multiple stablecoin liquidity pools with an APR ranging from 1.9% (for liquid tokens) to 32%.
3. Uniswap
A DEX platform where farmers can exchange tokens (with zero trust). LPs stake on both sides of the liquidity pool with a 50-50 ratio – while other crypto traders can then trade against this liquidity pool.
4. Compound
A leading platform for asset lending and borrowing – with a total supply worth $16 billion (in August 2021) and an APY ranging from 0.21-3%.
This is everything you need to know about what is yield farming in the crypto domain. At Binocs, we can help you calculate the exact taxes on every yield farming transaction. With our portfolio, you can track your investment performance across various yield farming platforms.
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Frequently Asked Questions
1. What is yield farming?
Yield farming is an effective method for cryptocurrency holders to earn an income by depositing their assets into DeFi liquidity pools.
2. What is crypto staking?
Crypto staking is the process where crypto users can lock their funds in cryptocurrency wallets to become part of a blockchain network. Similar to crypto mining, crypto staking enables users to delegate a part of their token holdings to the blockchain governance model.
3. Are there any risks in yield farming?
Yield farming has its share of risks, including high volatility – or extreme price fluctuations within a short period. Additionally, yield farmers can suffer losses when they invest in fraudulent projects or schemes. Additional risk factors include rug pulls, impermanent losses, and smart contract risks.
4. Is yield farming profitable in 2022?
Despite its many risks, yield farming can help you earn healthy returns on your cryptocurrencies. Yield farming can help you earn an APY of 1,000%. Some of the best DeFi platforms that you can consider for good returns are Curve Finance, Uniswap, PancakeSwap, and Venus Protocol.
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