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Yield farming (YF) in decentralized finance (DeFi) has become one of the hottest trends in 2021, giving investors an even greater chance to increase revenues.
Credible sources claim that 1.9 billion dollars are currently locked in DeFi. Cryptocurrency owners are adding more and more value to work in DeFi applications, motivated mostly by an intro of a brand new yield-generating pasture, Compound’s COMP governance coin.
In today’s article, OpenGeeksLab has rolled out a yield farming guide. We will route you through what yield farming stands for, how it works, why the concept is so popular. What’s more, you will learn how to calculate returns, what yield farming protocol to choose, and what benefits YF delivers. Let’s dig deeper into the topic!
So, what is yield farming in DeFi? What are its areas of implementation? Briefly, yield farming is a practice in the DeFi cryptocurrency world. It is the term that defines the process that stands for obtaining the highest yield and a method to earn more cryptocurrency with your cryptocurrency. In addition, it’s a chance to obtain extra yields from the protocol’s governance token.
We have more answers to this question, “What is yield farming in decentralized finance (DeFi)?” Traditional investors view crypto yield farming as bonds and dividends. What’s in common? Yield on DeFi coins fluctuates depending on how various projects roll them out. Like dividend payouts, in case the price per asset grows, the yield paid on your cryptocurrency provides users with new tokens; they cost more money. Millions of modern traders are interested in using this reward system.
Some experts compare this term to bank loans. Each time the bank borrows money from a client, they pay back the loan with interest. Banks are cryptocurrency owners. YF applies “idle cryptocurrencies” that would have been wasted away in an exchange or hot wallet to provide liquidity in decentralized finance protocols.
How did this term gain its popularity? It happened because of protocols like Compound and Aave. The value of digital assets locked in DeFi smart contracts went up rapidly from $670 million to $13 billion in 2020.
Most experts relate the yield farming boom to the start of the so-called COMP token. Past June 15 can be called a starting point. It is an ERC-20 asset that authorizes community governance of the Compound yield farming protocol. The owners of these tokens offer and vote on any modifications in the protocol. Governance coins pass all rights of ownership to asset holders. The question is how to make the network highly decentralized?
One way is distributing such tokens algorithmically, including liquidity incentives. It is rather attractive for market makers. It motivates them to create new tokens and provide liquidity. Since COMP was launched, many different DeFi platforms have offered brand new schemes to attract liquidity to a yield farming ecosystem.
Usage of the Ethereum blockchain is the most notorious when it comes to YF. The decentralized finance space is currently worth more than $121.5 billion. Earlier, ETH blockchain has suffered from certain scalability problems. That is why some experts like the “father” of Ethereum, Vitalik Buterin, claimed he would not dip his feet into YF until it stabilizes.
Yield farming token holders can use coins in many different ways. Tokens, as a rule, stand for ownership in something like a piece of a specific liquidity pool or access to some service. For instance, if we take Brave Browser, advertisements can be purchased just by using a basic attention token (BAT). Sometimes, you can use these tokens as funds within a set of applications. Online users can spend coins with each other in rather small amounts.
Those are all reasons why yield farming is in trend nowadays. Yield farming crypto is reportedly booming, and investors could see up to 50% returns last year. That is not a limit, and it’s never late to start investing in this field. As experts from Forbes fairly admit, all you need to benefit from YF development is the right timing and correct underlying instrument.
How does yield farming work? Before we move on, check out how we can answer this question. First things first, imagine a market for both DAI and USDC. These coins are worth one dollar each every time. If you are to set up a USDC/DAI pool, first, contribute equal numbers of both tokens. In a pool with just two DAI and two USDC, the price would be one USDC for a single DAI.
Next, this pool would possess one USDC and three DAI. The pool would be out of whack. A user could earn 50 cents by investing in a single USDC getting 1.5 DAI. That is a 50% arbitrage revenue, as well as the issue with restricted liquidity. In case there were 500,000 DAI and USDC of the same amount, a trade of one DAI and one USDC would have a negligible effect on the relative fee. It makes liquidity useful.
Understanding how yield farming works also requires knowing what a smart contract is as they play a specific role. Smart contracts that act as tiny computer programs serve as a bridge between your cash and the funds of other users.
Any type of lending is about making money, and crypto lending is not an exception. A lender earns fees in the shape of coins for their services. Yield farming is among the top popular methods of generating rewards with cryptocurrency holdings.
How about its working scenario? DeFi yield farming takes after auto-market makers (AAM). That is one of the numerous DEX protocols, which comprises liquidity pools and providers. Here are some main terms that you may face while working in this field:
Now that we’ve figured out the basics, let’s dive into how the entire picture looks like.
Pool’s activity is another factor that defines how much a participant can earn. Those are preferably stablecoins pegged to USD in DAI, USDT, BUSD.
Now that you know how yield farming works, you may wonder how much you can get in return. Below, you can find how to calculate your returns in DeFi YF.
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You should estimate this metric every year using a yield farming calculator. It will show the returns that you may obtain over a specified period of time. Usually, two metrics, APY and APR are enough, but some use one more indicator, which is total value locked. So, here is how to calculate returns for LP.
You may wonder what compounding is. In simple terms, it stands for directly re-investing revenues to make even more money. Using APY and APR interchangeably is possible.
Still, estimating ROI in this field is almost as difficult as predicting outcomes of random table games like keno or bingo. Those calculations would never be 100% accurate. That is because YF is a rather competitive and rapidly-paced marketplace. Thus, the prizes can change unbelievably fast. In case one specific strategy is effective during a long period, many participants would implement it. As a result, it may prevent high returns.
Keep in mind that farming isn’t immune to capital losses. The farming transaction includes virtual transaction protocols between a couple of anonymous parties with no central enforcement body. If any system error takes place, the financial info risks being lost. In the case of blockchain blocks all shapes of system delegation, the records would be secure.
ROI can be divided into three separate categories when it comes to a yield farming ecosystem. They involve:
That is how you get a return on investment when dealing with YF. Let’s move to the best protocols that you can pick for yield farming.
Now, you may ask how you can make money using this principle. Keep in mind that multiple YF strategies exist, and new ones pop up regularly. Using them all at a time is impossible. Remembering all of them by heart can be challenging as well.
To make things right, you should study every platform of your preference to discover which strategies it recommends. What’s more, learn how decentralized liquidity protocols work in general – it would be enough for your first time.
One thing any expert can tell you for sure is that you’d better avoid blindly depositing cash on the first website you find. On top of that, be aware of the risk management rules. To ease your task, we’ve gathered some trusted YF protocols that many users recommend. You can discover them below.
These are the top YF protocols that you can trust. Another piece of useful information is provided further, and it will reveal the benefits of DeFi YF development.
DeFi YF unlocks earning opportunities for LP and platform owners equally. As a result, we can witness an increased demand for DeFi yield farming development. It makes no wonder: this process has plenty of perks. Let’s focus on the four main ones.
This list of benefits is not complete. In general, YF obtained lots of attention as it’s one of the most lucrative types of crypto investment with high liquidity. Simplified regulations and increasing adoption among participants allow this yield farming to develop further.
As in any other area, yield farming has both perks and pitfalls. You can check out some of them below.
So, there are two sides to the coin, but, we believe, that you should not miss an opportunity and try YF, focusing on the benefits it can provide. Yet, keep in mind all potential risks to avoid problems.
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As you can see, you have enough good reasons to choose yield farming as a possible investment field. YF will probably become an efficient market with many opportunities to discover high return rates compared to traditional methods. That is to say, while cryptocurrency becomes mainstream, demand for cryptocurrency-based financial services will go up.
But it’s quite a complex strategy as well. Hence, if you are about to take an active part in the digital asset economy, you should study this phenomenon in-depth. You can do it alone or contact a reputable DeFi yield farming development company that is OpenGeeksLab.
We do believe in the successful future of YF and are here to contribute to its development, sharing our knowledge of this field. OpenGeeksLab offers a unique solution which goal is to digitize cash and develop interoperability to any system that you may choose. We are at your service in case of any questions. Let us give you a helping hand with your project. All you need to do is fill out this contact form.
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