101 on DeFi Yielding: A Comprehensive Guide For Beginners
When Satoshi Nakamoto released the whitepaper on Bitcoin in 2008, he never knew that there would be anything like DeFi yielding. Everybody saw decentralized technology capable of supporting a digital currency. However, as with every novel technology, there is always bound to be innovation along the way. In the case of blockchain technology, decentralized finance (DeFi) is one such innovation.
To talk about yield farming, we have to explore and understand decentralized finance (DeFi).
Also Read: The rise of decentralized finance and why banks need to pay attention
What Is Defi And The Journey So Far?
Decentralized finance (DeFi) has been a buzz work in the crypto and blockchain space for quite some time. It is an ecosystem of financial applications built on blockchain networks. DeFi is more of an open-source, permissionless, and transparent financial network accessible to everyone. This financial system operates without a central authority controlling the affairs of the network. Users of the system maintain full control of their assets. They are able to interact with the ecosystem through peer-to-peer (P2P) and decentralized applications (dApps).
Thus far, DeFi has given us easy access to financial services, especially for people isolated from the traditional financial system. The interoperable DeFi applications are built on public blockchains that will help create new financial products and services. It will also help create new frontiers in the current financial market. With the way it is going, we might wake to see Wall Street investing in DeFi.
DeFi Ecosystem and Applications
The DeFi ecosystem, through its applications, eliminates intermediaries from all kinds of financial transactions. This ecosystem was previously known as “open finance” before it became commonly known as decentralized finance. Most of the DeFi applications are built on the Ethereum blockchain network. Here are some of the most popular decentralized finance (DeFi) applications.
- Yield farming
Here, professional or knowledgeable traders can take risks through lending or staking their crypto for higher returns. Users scan through the different DeFi tokens searching for opportunities that will provide higher returns. Yield farming is risky and only advised for professional crypto traders who understands the field.
- Decentralized exchanges (DEXs)
They are online exchanges or applications that help users swap currencies for other currencies. It can be USD for BTC or ETH for USDT. DEXs are highly active DeFi applications that connect users directly so they can transact cryptos with one another without the need for an intermediary.
- Lending Platforms
They are DeFi applications that leverage the power of smart contracts to replace middlemen like financial institutions and banks. These applications manage their lending and borrowing services efficiently.
- Liquidity mining applications
They DeFi applications that attract users to their platform by giving them free tokens. Many people have called it the most active form of yield farming in the crypto industry.
Putting Your Crypto To Work; Yield Farming
Crypto takes after fiat in many aspects, such as investment tools and a means of payment. The concept of yield farming started receiving recognition in the crypto space when the Ethereum-based credit market (Compound) started giving out COMP tokens to the protocol’s users. Since then, yield farming has become so popular. The concept is used to describe how users can stake or put their crypto coins in certain protocols to earn their tokens. Some other people describe it as liquidity mining, but they both imply the same thing.
What is Yield Farming?
The term yield farming or DeFi yielding is the process of receiving token rewards for staking or lending your crypto assets. Just like putting your money in the bank and being paid interest. In the crypto space, when you stake your crypto asset, you will likely be rewarded with interest in the form of tokens. However, the reward varies from one project to another.
When a protocol gives you high amounts of newly generated cryptocurrencies as a reward for staking, and you keep moving from one protocol to another, it is known as yield farming or DeFi yielding. The tokens can rapidly appreciate in value and make rich as an early investor. For example, someone asks you to deposit dollars and Euros with him/her in return for thousands of coins as rewards. These little coins can make you very wealthy with time while your dollars and Euros are intact in smart contracts. You can also withdraw or extract them at any time.
The yield farming process is not like the ICOs of 2017; it is much more complicated than that. In DeFi yielding, users need to lock their crypto assets early on in order to maximize gains. Also, they need to constantly keep an eye on the platform to maximize the rewards from farmed tokens. With more than $7 billion currently locked in DeFi, the race is on for who will stand the test of time. Until then, let’s keep farming and increasing the size of our portfolio.
Types of Yield Farming
There are different ways users can engage in yield farming. We all are part of a massive experiment to eliminate intermediaries from financial transactions. Here are the different types of DeFi yielding in the crypto industry:
- Token Farming
Certain protocols incentivize liquidity providers with fees; certain protocols add a giveaway of protocol tokens. Yield farmers can earn native tokens for staking or investing their crypto assets in the protocol. You can earn tokens from protocols like yEarn and Compound for providing liquidity to the pools. When the pool has low quantity, the reward rate tends to be higher and attracts more yield farmers.
Some protocols like Ampleforth and BNS Finance utilize liquidity pools from other platforms like Uniswap to share their rewards to users. On such platforms, users will be required to add a set of tokens to pools on Uniswap. Then they will have to stake the Uniswap tokens on the platform to commence farming the protocol tokens. All these protocols use a different strategy to reward their users. Also, they have different use cases for their platform tokens too.
- Liquidity Mining
This is the process whereby protocol users use their crypto assets to provide liquidity on decentralized exchanges. This liquidity provided by these users helps other traders to swap tokens in the shortest possible time. If a trader wants to convert his/her BTC for ETH on a centralized platform like Coinbase, buyers and sellers are matched. The case is quite different for decentralized exchanges. To provide immediate swaps with the highest possible value, the platform allows users to provide their tokens as liquidity.
Suppose a user tries to swap ETH for BTC on a decentralized exchange like Uniswap. In that case, the protocol will deposit ETH and withdraw BTC from the much liquidity it has acquired from liquidity providers. The liquidity providers will share the trading fees paid by the traders swapping tokens on the Uniswap protocol.
Also Related: Top DeFi projects to look for in 2021
Pros and Cons of Yield Farming
Every new technology has its pros and cons, and yield farming is no exception.
Pros of yield farming
There are many advantages of DeFi yielding in the crypto industry, and we shall consider quite a few of them.
- Yield farming strategy can be carried out with different targets or spaces.
We currently have a lot of DeFi protocols specifically designed for yield farming. It is quite interesting to note that some of these protocols have been in operations for several years and have proven their robustness.
- The return on investment is quite high.
Generally, yield farmers invest or stake their crypto assets for a period of 6 months to 1 year. The returns can also be reinvested to generate a higher percentage of profits. Generally speaking, yield farming greatly favors crypto whales.
Cons of yield farming
- The strategy is a complex one: It is not recommended if you don’t have advanced financial knowledge on the principle of DeFi yielding.
- It only those who have a large amount of investment capital: If you have little capital, your chances of making profits will be close to zero. In fact, you may even be at a loss by paying commissions.
- Risk of theft of funds: If the smart contract of the yield farming platform has been properly audited, users may lose their crypto assets to hackers. Some vivid cases include the likes of dYdX and bZx.
Yield Farming Platforms
The number of yield farming protocols and decentralized platforms offering DeFi yielding services has been growing by the day. Below are the most renowned DeFi protocols offering yield farming in the crypto space.
Compound Finance (COMP)
It is a DeFi yielding platform that operates on the Ethereum blockchain. The system powers a distributed network of competitors that acts as a replacement for a money market.
This DEX utilizes several crypto tokens to enable borrowing and lending without intermediaries or third parties. As a user, you can loan out any of the cryptos offered by Compound. On the other hand, borrowers can only borrow up to the amount of their collateral. The borrowers are at risk of being liquidated if the crypto assets become more valuable than the token collateralized.
As you can decipher from its ticker symbol LEND, Aave is a DeFi yielding protocol designed for decentralized lending and borrowing of crypto tokens. The
protocol is built on the Ethereum blockchain. Its flash loans are the reason for the success story.
Curve Finance (CRV)
This is a decentralized exchange liquidity pool that is built on the Ethereum blockchain. It is designed for the trading of stablecoins only. The platform has low slippage when swapping coins and lending and borrowing tokens too.
Although it is relatively new in the space, it has risen to the top spot based on the total value locked up in USD and ETH. The platform exploded in popularity as a result of the high number of tokens launched on the platform. Early investors made a fortune, but most of the latecomers got burned hard.
It aggregates lending services like LEND, COMP, etc., in order to optimize token lending.
Its token has a maximum supply of only 30,000, making it even more scarce than bitcoin itself. It is the most expensive crypto token in the entire market within months after its launch.
Synthetix Network (SNX)
It is a token trading platform built on the Ethereum network. On the platform, crypto traders place bets on all types of assets available as ERC-20 tokens. Also, the platform offers DeFi derivative trading.
Although there are over 200 million total max supply of SNX tokens, we currently have 125 million in circulation.
The yield farming crypto market will keep involving as more innovative projects enter the market. However, one remains certain, the traditional financial institutions and banks are gradually being replaced by DeFi yielding protocols. Before you get involved in any of these protocols, ensure you have the requisite knowledge required to succeed in such a complex market.