Yield farming, also known as liquidity mining, has become a popular activity in the world of decentralized finance (DeFi). Yield farmers aim to generate passive income by providing liquidity to DeFi protocols and earning rewards in return.
In this detailed guide, we explore what yield farming is, strategies and risks involved, as well as the tools and platforms being used.
What is Yield Farming?
Yield farming involves locking up cryptocurrencies into DeFi protocols that provide liquidity for decentralized exchanges, lending platforms, stablecoins, derivatives, and more.
By providing liquidity, yield farmers earn fees and a share of the trading volume on the platform. They also earn governance tokens or a portion of the interest from loans.
Top DeFi protocols like Uniswap, Compound, Aave, Curve pay attractive yields to liquidity providers, often over 10-20% APY.
Yield Farming Strategies
There are a variety of strategies that yield farmers utilize:
- Providing to AMMs — Supplying crypto to automated market maker (AMM) exchanges like Uniswap to earn trading fees and governance tokens.
- Liquidity Pools — Adding funds to liquidity pools on lending platforms and DEX aggregators to earn interest and swap fees.
- Token Staking — Staking governance tokens earned from other yield farming to get additional yields.
- Leverage Farming — Using lending protocols to multiply yield farming positions for greater exposure.
- LP Token Staking — Staking the LP tokens earned from liquidity pools to optimize compensation.
- Chain Hopping — Moving funds across multiple chains like Ethereum, BSC, Polygon to find the best yields.
Risks and Challenges
While yield farming offers high upside potential, participants take on substantial risks including:
- Impermanent loss — If asset prices change, liquidity providers make less than simply holding the assets.
- Smart contract bugs — Flaws in smart contract code underpinning protocols can lead to loss of funds.
- Price volatility — Cryptocurrency price swings can rapidly change yields and cause losses.
- Platform hacking — DeFi platforms are prime targets for hacking attempts and exploits.
- High Ethereum gas fees — Transacting and moving funds on Ethereum can eliminate profits from yields.
Yield Farming Tools
There are various tools and platforms yield farmers use to enhance operations:
- Aggregators — Platforms like Yearn Finance automatically move funds for optimal yields.
- Farming assistants — Apps like Harvest Finance help efficiently compound and track yield positions.
- Analytics — Dapps like Yield Farming Stats provide analytics on yields, TVL, and ROI across platforms.
- Portfolio trackers — Trackers like ZapperFi provide a dashboard to view and analyze yield farming performance.
- Secure wallets — Non-custodial wallets like MetaMask allow safe storage and interaction with protocols.
- Cross-chain bridges — Bridges like Multichain (formerly Anyswap) enable moving funds across chains for yield arbitrage.
Leading Yield Farming Platforms
Top DeFi platforms that provide yield farming opportunities include:
- Uniswap — AMM exchange that rewards liquidity providers with fees and UNI governance token.
- Curve — DEX optimized for stablecoin trading that compensates with CRV token.
- Aave — Lending platform that gives interest earnings and AAVE token to lenders.
- PancakeSwap — Popular AMM on Binance Smart Chain with CAKE governance token rewards.
- Convex Finance — DeFi platform that optimizes Curve yield farming through staking and strategies.
- Yearn Finance — An aggregator that automatically moves funds seeking the highest yields.
Yield farming presents a powerful way to leverage decentralized finance protocols for earning attractive passive income. However, the risks involved necessitate thorough research, active position management, and risk mitigation practices. Used properly, yield farming can be a lucrative component of a crypto portfolio.