Yield farming is a strategy for investing in decentralized finance. In which, a loan or stake is a method of earning interest or transaction fees from cryptocurrency coins or tokens.
In the past few years, ( DeFi ) decentralized finance has opened new revenue streams for investors by removing intermediaries in financial transactions. Moreover, A cryptocurrency loan or stake aims to reward you with transaction fees or interest in return for your crypto coins or tokens.
You are technically loaning the bank money and earning interest. Where, the only risk with yield farming is that it can be volatile and complex, unlike putting money in a bank.
Cryptocurrency moves through different marketplaces in yield farming. Whereas, it has another element in which it becomes less effective as more people learn about it.
However, currently, yield farming is the most significant growth driver of the DeFi sector, helping it grow from a market capitalization of $500 million to $10 billion in 2020 alone. Find out more about yield farming here.
How will yield farming work?
Liquidity providers (LPs) are the users who provide their cryptocurrencies to the DeFi platform.
The LPs contribute funds to a decentralized application (dApp) based on smart contracts that contain all the funds. While, token holders who lock their tokens into a liquidity fund receive a fee or interest derived from the underlying platform that the liquidity pool is running on.
It’s a method of earning income by lending your tokens through a decentralized application (dApps). Smart contracts with no middlemen involved handle all loaning.
The liquidity pool powers a marketplace where tokens can be lent and borrowed. The use of these marketplaces incurs fees from users, and those fees are use to compensate liquidity providers for staking their own tokens.
On the Ethereum platform, yield farming is the most common practice. That is the reason the rewards are of the ERC-20 token’s type.
Nevertheless, lenders are permitted to use the tokens, most lenders are speculators seeking arbitrage opportunities by taking advantage of the token’s market fluctuations.
What made yield farm so famous?
It has boomed since the launch of the COMP token, a governance token of the Compound Finance ecosystem. DeFi token holders can take part in the protocol’s governance by holding governance tokens.
Governance tokens are often algorithmically distributed with liquidity incentives to launch a decentralized blockchain. These incentives provide potential yield farmers with a motivation to provide liquidity in the pool.
Many platforms for yield farming include Aave, Compound, Uniswap, Sushiswap, and Curve Finance.
How to calculate yield farming returns?
Annual percentage yield (APY) is the unit of measurement for the yield farmings process. In other words, it represents the user’s return on investment over a year.
A portion of the APY calculation accounts for compound interest. Though lenders can use the tokens however they wish, most lenders are speculators looking for arbitrage opportunities by tapping into the token’s fluctuating prices.