DeFi, a revolutionizing technology that came to remove mediators or third parties in financial transactions, has shown various channels of earning for investors. Yield farming is one of those income avenues in Decentralized Finance. Then, at this page it may include crypto lending or crypto staking to make gains in the form of transaction processing fees or interest. To some extent, it resembles earning interest from a bank account, as an individual is technically lending his hard-earned money to the bank. Contrary to depositing in the bank, yield forming might be risky, dynamic/fluctuating, and complex.
What Is Yield Farming?
Yield Farming is the mechanism to utilize DeFi in such a way as to maximize the returns. An individual can lend or borrow cryptocurrencies on a Decentralized Finance platform or exchange and receive digital currencies (coins and tokens) in return for their services. Yield farmers who wish to enhance their productivity may use more sophisticated strategies. For instance, yield farmers may continually shift their digital currencies among various loan platforms to maximize their gains.
Yield farming includes shifting cryptocurrencies through multiple marketplaces. There exists another feature of yield farming when it turns out to be less effective and less efficient when it comes to the knowledge of more people. But yield farming is recently the most crucial growth driver of Decentralized Finance, supporting this sector to grow from a market capitalization of 500 million dollars to 10 billion dollars in 2020.
Types Of Yield Farming
Typically, yield farming is divisible into four types.
1. Liquidity Providers
An individual deposits two coins/tokens to a decentralized exchange to offer trading liquidity. DEX deducts a small fee to exchange the two coins, which are paid to liquidity providers (LPs). This fee is often paid in the latest LP coins.
2. Lending
A crypto holder can lend his coins/tokens to someone willing to borrow them via Smart Contracts. One can earn yield from the interest paid on the loan amount.
3. Borrowing
Formers may pledge one coin and get a loan from another. The borrowed coins are utilized for farming yield. In this way, the farmers possess their initial holdings, which may appreciate with time, while also farming yield on their borrowed tokens.
4. Staking
There are two types of staking in the ecosystem of decentralized finance. The main form is on the POS blockchains, in which an individual earns interest by pledging his/her coins to the platform to offer security. The 2nd is to stake Liquidity Provider coins received by supplying a decentralized exchange with liquidity. It enables them to earn yield twice.
How Does Yield Farming Work?
Individuals offering their digital currencies to run DeFi platforms are called Liquidity Providers (LPs). They offer their crypto holdings to a liquidity pool – a Smart Contract-based DApp that holds all the funds. After liquidity providers lock their coins into a liquidity pool, they receive a fee/interest from the underlying DeFi network on which the liquidity pool resides. An individual gets an income opportunity by lending his holdings through a DApp. The entire process takes place through Smart Contracts with no trusted third parties.
These liquidity pools fuel the marketplace where anybody can lend/borrow coins. Users are charge a fee for using these markets, and the fees are use for making payments to LPs for staking their coins in the liquidity pool. Most of the time, yield farming is done on the Ethereum network. This is why rewards are in the form of an ERC-20 token. How To Calculate Yield Farming Returns?
The returns in yield farming are compute in the form of Annual Percentage Yield (APY). It is the RoR an individual gains over a year.
