What is Yield Farming and How does it work?
In the Crypto-world or Decentralized Finance i.e. DeFi- world Yield-Farming has been yet another subject that has grabbed the attention of many crypto-economists.
“Yield Farming is the trade of decentralized monetary standards or currencies to get better returns as extra digital currencies”. It is a sort of variable interest earned that the DeFi market provides.
How does Yield Farming work?
Yield Farming can be done by using various protocols like compound, curve, synthetix, etc. There are various steps involved in the Yield-Farming strategies –
- Lending and Borrowing — First of all we need to buy a token provided by various protocols, such as USD, which can be henceforth bartered online to have a better APY.
- Liquidity Mining — It is done by investing/stacking in Liquidity Pools which provide the users with profitable incentives in the form of LP tokens. It also allows the user to swap tokens with the pool. This makes the Liquidity pool an Automated Market Maker i.e. AMM.
- Leveraging — This can be done by providing the token as collateral to the lending protocol and buying another token that can be further used as collateral and the process can go on until the person obtains speculated returns while leveraging the initial incentives.
Measuring units in Yield Farming
- APY — The yields are usually generated annually, hence ‘Annual Percentage Yield’ i.e.APY figures are used to compare yields generated annually.
- APR — Annual Percentage Rate’ or APR, as the name suggests, is the rate of interest produced periodically.
- TVL — It is the measure of how much crypto-money is locked in the pool. It also acts as an effective metric to compare the market share of DeFi protocols.
Why prefer Yield Farming?
- Since the entire system works in decentralized blockchain technology it does not involve a single centralized authority.
- It is a smarter way of investing money in DeFi systems, as they add to your credibility and money balance. Thus, acting as an extra income.
- The absence of a third party makes the process of lending borrowing cheaper.
- Peer to Peer encryption ensures secured transactions.
- Decentralization also provides transparency.
- There is no need for KYC, unlike traditional banks.
- It is available 24/7 so the transaction can be made at any hour.
Risk Factor
Yield Farming is as dynamic as share markets, so sometimes you may not get the speculated amount in return. There are also chances of having a situation of impermanent loss. The risk of inflation, particularly with a high token value is another risk factor. Also, sometimes it is subjected to operational security leaks which might lead to the problems created by third-party involvement.
Final Thoughts
In short Yield, farming can provide you with a better platform to invest your e-money and make extra profits simply by trading in liquid pools. Though it involves certain risks, it can be minimized by collecting relevant information about the protocol you use, the amount you invest, consulting a pro-digital-economist, etc. Keeping in mind the various risk factors and required knowledge, one can make unbelievable profits through Yield Farming. We are at Kointrack, making blockchain technology accessible to the people.
