What is Yield Farming?
Yield farming is the process of putting your cryptocurrency in the most optimized spot so that it will earn you even more free crypto.
Yield is a financial term that means what you get for investing, and the term farming is used because it represents the possible exponential growth you can receive by finding the right place to invest it.
To put this into perspective and help get you excited for this blog post, most United States banks can promise around $1 a year for every $1,000 invested. Still, some big-name yield farming opportunities are currently advertising $3,000 a year for every $1,000 invested.
How does this work? Is yield farming a scam?
Before we start this blog post, you might want to grab a chair and pull up your pants because this topic is a fun one.
However, it does get quite complicated. Our job here at Shavuna is to make it very understandable, and to do that; you will require some knowledge on topics that we’ve already explained.
We highly suggest that you read our post on liquidity pools, impermanent loss, and how an automated market maker works before reading this blog post. They will significantly improve your understanding.
But sticking in line with our original slogan, we will try to make the topic of yield farming so simple for anybody to understand it.
Let’s get started.
Right now, lending and borrowing in cryptocurrency are very new. Because of this, there are a ton of entrepreneurs and developers working very hard to create the next big bank but with the help of blockchain technology.
Some of these opportunities have a crazy amount of money flowing into them, and yield farming is essentially figuring out the best place to put your money to see the highest returns.
Four Ways For Yield Farming
Now, there are many different ways to do that, and in this article, we will cover four primary methods.
- Liquidity Providers.
Investors can supply coins and tokens to a decentralized exchange. In return, these exchanges take a minimal fee of all the trades happening on their platform, and they give that back to the investors.
If there are a ton of trades happening and the investor is one of a few other investors, they can earn a very high return on their initial investment.
Here’s a really quick example.
Let’s say you have $1,000 to invest. So you supply $500 of Ethereum and $500 worth of basic attention tokens into a liquidity pool on Uniswap. You can read our ost on Uniswap if you have no idea what that is.
Uniswap is a decentralized exchange that runs on the Ethereum network.
Basically, your $1,000 means that you now own 1% of that entire pool because some other investors before you deposited $99,000. And along with your investment in this example, the pool’s total is one hundred dollars.
The next day, around 1 million dollars gets traded back and forth between Ethereum and Basic attention token on Uniswap, and Uniswap’s fee is 3%.
This means $3,000 worth of fees were collected during those trades. Well, your percentage of those fees is $30 because you own one percent of the pool, and so you earned $30 in one day based on your initial $1,000 investment, which is a considerable return.
The money came from those traders who happily paid that fee to switch back and forth from Ethereum, the Basic attention token using the funds you provided.
If you want to, you can actually go to info.uniswap.org and see current rates for providing liquidity. Pancake Swap is another major decentralized exchange that runs on the Binance Smart Chain, which is very similar to Ethereum but has lower gas fees.
Quick swap is another big player that actually lets you switch out your Matic tokens which has even lower fees than the Binance Smart Chain at the moment.
- Borrowing and Lending
Borrowing and lending are two major functions for yield farming, and there are many ways you can produce income with these methods. Let’s go over these.
Many borrowing and lending services will reward those who lend their crypto to the platform. For example, compound and AAVE show their lending rates within their app.
Some rates for specific coins go over 30% APR. While others are close to zero, and since many
traditional banks offer 5 APR, and the stock market has roughly returned 7%; anything above this seems like a delicious alternative to any investor.
Plus, investing is very simple, and you can cash out at any time.
The other side of lending is borrowing, and you can make money from this as well. Imagine if you had some Ethereum laying around and wanted to take out a loan but didn’t want to cash out the Ethereum because you thought it would go up in price.
You believed in the Ethereum project. You could borrow some DAI, a stablecoin, and lock up your Ethereum as collateral.
When it comes to crypto loans, all loans are always over collateralized. This means that you must provide more money than the loan is worth when you take a loan.
It might sound crazy, but it means that there is no way you can run away with the money you borrowed because there’s something of a higher value that you’d rather get back.
Continuing with an example, let’s say you have $15,000 worth of Ethereum. You can borrow and use $10,000 worth of DAI till you want to pay it back on the AAVE platform.
Now, of course, there’d be interest, and you’d always want to make sure that you pay that interest off. But whatever you want, you can pay back the $10,000 of DAI and get back your initial Ethereum deposit which hopefully has increased in value.
You can use the value of your Ethereum while still allowing it to appreciate in value.
Now, this is a form of yield farming. You can think of this as comparable to taking out a loan on the house. You can use the money of the house’s value while the house still grows in value.
- Leveraged Lending.
The last part of lending is leveraged lending. We call this lending with steroids. Basically, you lend your money to platforms like Compound or AAVE, take what you can borrow, and then reinvest it.
For example, if you deposit $100, where the basic attention token, these platforms allow you to borrow $60 and DAI from it.
First of all, you need to know right now; there’s a 30% APR for providing Basic attention tokens. So, you’re already earning passive income through this, but it’s not always 30%.
Right now, the price of basic attention tokens is very volatile. That is why the APR is so high.
Next up, let’s get to the steroid part.
You take that sixty worth of DAI that you had, convert it back to basic attention token using a decentralized exchange. So now you have $60 worth of basic attention token, and you resupply it back to compound or AAVE.
Now you have $160 earning that 30% APR. However, since you have deposited another $60, you can take out a loan of $36 DAI. You can repeat the process, buy more basic attention tokens and redeposit, and by the end of three iterations, you have almost $200 of basic attention token earning 30% APR.
This is the crucial part. You only initially had $100, but you’re earning 30% interest on $200 worth of assets, and this is the golden egg of yield farming.
Now, there are risks, and the first risk you should know about is that if basic attention tokens price falls, the platform may automatically sell your positions which is technically called being liquidated to cover the lender’s funds.
You are essentially creating a margin option, and again, this is a topic that could be its whole article.
The third form of yield farming is basically staking. So staking is technically a form of yield farming because you can buy coins, stake them, and earn more free coins.
The first example we’re going to go over is Tezos. Currently, Tezos has around a 6% APR. Although, you have to have the hardware and the knowledge to set up what is called your own staking node that will definitely be reliable throughout the year.
One common way to avoid this is to stake through a platform like Binance or Coinbase, which takes a cut of that 6% that you earn, but at least you’re still making something.
Next up, we have Ethereum 2.0. Ethereum is moving from proof of work to proof of stake which means instead of a bunch of miners doing a ton of work to mine Ethereum, the code is changing so that one miner at a time will earn that Ethereum and validate those blocks.
You can participate in the network and get the lucky chance to be one of these lucky miners, and if you do, you will earn Ethereum.
Again, setting up a staking node is quite complicated for beginners, but platforms like Binance or Coinbase are already offering to do it for you for a certain fee.
Lastly, we have LP tokens. LP tokens are tokens that you get when you provide liquidity. For example, if you provide liquidity to Uniswap using Ethereum and Basic Attention Token, you might receive some of what is called ETH-BAT Uniswap tokens.
These tokens are redeemable at any point for your percentage of the pool’s value. However, many platforms allow you to stake these tokens to earn even more interest in them. Why?
Well, they want to incentivize you to leave those coins alone so that you don’t pull them out and remove your liquidity and the interest rate they provide does just that.
Now, it should be noted that many liquidity pools will give you their native tokens such as UNI or CAKE as a reward for staking your LP tokens, and these tokens are usually deflationary in nature which means that the platform just keeps making more of them and generally, this means the price will decrease.
This is why many investors do not recommend investing in a liquidity pool token because they say the price will eventually go to zero.
- Holding Coins Have a Redistribution Fee
The last way for yield farming is to hold coins with a redistribution fee. For example, the coin Safe Moon has a 10% transaction fee.
Half of that 10% is burned forever, and the idea of this is so that the supply of Safe Moon is consistently decreasing, which theoretically should increase the price because there’s constantly less and less of it.
The other half of that 10% is redistributed evenly among all holders. So, just by holding the token Safe Moon, you will earn free Safe Moon while everyone else does their transactions.
You have to be very careful with the token like this, though, as nothing like this has ever been scaled to such a large market cap before and the risks associated with the deflationary coin are something to think about.
You should definitely do your own research before investing in any coin or token. Many experts say Safe Moon is a speculative investment because no other crypto that has a transaction fee similar to Safe Moon has been created.
In short, even the experts have no idea what will happen long term.
As we end this blog post, you should know that high return comes high risk, and yield farming has some high risks. One of the risks is rug pools and impermanent loss. We have articles on these topics, and you can check them out.
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Thanks for reading. I hope you enjoyed it. I hope you learned something and we hope to see you next time.