Helpful Tips for DeFi Yield Farming
According to DeFi pulse at the time of writing this post, the DeFi sector is currently worth US$62.51 billion. This mirrors the immense growth the sector has experienced compared with the US$10.3 billion worth as of 2020. While some believe this growth is only for a short while, recent technological developments in the sector show otherwise.
Among the many tech developments helping to push continuous growth in the sector, yield farming stands out as one of the most popular investment techniques currently attracting avid investors to the DeFi scene.
What is Yield Farming?
Often referred to as a form of liquidity mining, yield farming is a DeFi protocol where crypto holders lock their cryptocurrencies in liquidity protocols and earn rewards. Although it may look similar to Proof of Stake staking, yield farming follows a much more complex mechanism. It relies on liquidity providers (LP) to add funds to liquidity pools (a smart contract that holds funds) by locking their digital assets in the pool. These LPs then get rewarded, via fees and tokens generated on the DeFi platform, over time for providing liquidity to the pool.
In other words, yield farming involves lending cryptocurrencies to DeFi protocols in order to earn rewards.
How does Yield Farming Work?
The first step in yield farming requires the user to add funds to a liquidity pool. Usually these pools provide liquidity to a DEX platform. The user becomes an LP once the funds have been added to the pool. Popular types of funds deposited are often stablecoins such as USDT, USDC and DAI. There are hundreds of tokens and coins currently being locked in DeFi platforms, with the list growing each day.
The LP then receives rewards for locking funds in the pool. The rewards are usually based on the amount of funds locked in. In general, the higher the funds locked, the higher the rewards. These are fees generated from the DeFi platform. The LPs can further choose to deposit their rewards in a liquidity pool to generate more rewards, essentially compounding their returns. LPs often move their funds around different pools to generate higher overall yields, since the ROI fluctuates day by day for a given pool.
Yield farming provides a means of passive income for crypto holders. You can potentially earn more than you would have by just holding your crypto assets, if you avoid the common pitfalls. Here, we present you important tips to stay ahead of the game.
Tips for Better Rewards
DYOR: Do Your Own Research
While yield farming does provide a good means of passive income, it is important that you do proper research on the different DeFi protocols, pools and the risks involved in yield farming. Do not just lock in your crypto assets blindly in any pool, since insane APYs can seem attractive at first sight, only to be riddled with high risks found later.
There’s no (long term and sustainable) get rich quick scheme here. Take your time to learn about the dynamic strategies in yield farming and which ones are best to use. Yield farming can be very risky as well — you stand to gain a lot and lose a lot as well. The larger the yield, the larger the risk is involved so do your due diligence well.
Yield farming is rapidly changing, and so should your ability to keep up with the fast changes.
Choose platforms that suits your comfort level
One problem with many DeFi platforms is the complicated, or albeit, lack of user interface. This makes it difficult for newbies and users in general to navigate the platforms when compared with centralized exchanges. Seek out platforms you can easily understand and navigate to make the yield farming process easier for you.
Know what the DeFi jargons are and be comfortable depositing, withdrawing, claiming and otherwise transacting your funds with smart contracts. Understanding the different chains that yield farming is built on (for example Ethereum vs Binance Smart Chain vs Ontology) are crucial. Be able to use the different types of wallets (Metamask, Trust Wallet, WalletConnect, etc) and know what the total fees are before you jump in.
Consider the risks
DeFi protocols are typically built on smart contracts and can be prone to bugs and hacks. You could lose all of your funds at any point of failure. It is important that you consider this well before locking your crypto assets. Good practice is to check if the DeFi platform’s smart contract code has been audited by reputable companies, and make sure they are not just an Alpha product with zero audits.
If you provide a pair of assets to a pool, you should take time to really grasp the concept of impermanent loss. This is a fundamental concept to know when depositing into Automated Market Maker (AMM) smart contracts.
Yield Farming is Full of Opportunities
Undoubtedly, yield farming is a novel means of earning passive income for crypto holders. It also goes beyond providing income for users while it produces higher liquidity for DeFi platforms which is necessary for mainstream adoption of DeFi. However, cautionary steps still need to be taken before hopping on the rave. The more you DYOR, the better yield farmer you’ll be.
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