As a result of DeFi’s robust development is the increasing influence of Yield Farming. Yield Farming is becoming a buzzword these days in the crypto community. To make money safely from Yield Farming, you must first understand its basics to maximize your profits and prevent potential risks. Let’s find out in the article below.
What is DeFi?
First, let’s take a look at DeFi. DeFi is an acronym for Decentralized Finance (decentralized/open finance), used to refer to financial applications built on Blockchain. Simply put, DeFi is the cryptocurrency version of the financial industry. But unlike the traditional financial sector, DeFi has no centralized governing body. This means that the crypto community will make all the critical decisions together.
DeFi guarantees the following characteristics:
- Permissionless: Open to everyone, everywhere.
- Transparency: All activities are public.
- Trustless: DeFi does not depend on the beliefs of the parties involved.
To fully understand DeFi, the simplest and most direct way is to look at its current products. One thing all of DeFi’s products have in common is that they are all Blockchain-based.
What is Yield Farming?
Yield Farming is a means for users to earn passive income by providing liquidity, depositing cryptocurrency to DeFi liquidity pools, or staking pools. In short, users will lock their funds into a DeFi application. The project will automatically pay the “productive farmers” with cryptocurrency rewards over time. This Yield Farming model is similar to when you deposit money in a bank and receive interest. You will now deposit Crypto through lending platforms and receive interest in Crypto.
These rewards are typically paid out in governance tokens that DeFi projects use as equity-like tools to facilitate community management and sometimes as transaction fees that all liquidity providers ( LP) earned on decentralized exchanges like Sushi and Curve.
Furthermore, Yield Farming means “productive farming.” If farmers measure their productivity, yield equals the total amount of agricultural products they have harvested. Then in the crypto space or decentralized market, DeFi will use its output to make a profit.
How Yield Farming Works?
Yield Farmers can become borrowers, lenders, or trade tokens with each other through smart contracts. Yield Farming is associated with AMM (automated market maker) models. For example, Uniswap floor. For Yield Farming, loans provided from liquidity providers are made through the pool, which can be understood as smart contracts.
Between these smart contracts will appear fees for borrowing, lending, and trading. These fees are considered revenue by the respective liquidity providers. That is, they will be divided according to their percentage in the pool. In addition to this revenue, some protocols or protocols also use the form of liquidity mining. It can be understood that liquidity mining is simply that you also receive more tokens for your revenue in addition to receiving tokens from providing liquidity.
The Perks of Yield Farming
By implementing the bootstrapping methodology, Yield Farming has successfully recruited participants in the short term. This is seen as the start of a new era for the DeFi community.
Alternatively, the birth of Yield Farming has a significant influence on other procedures, and this impact can allow both to improve. There have been several conversations between the two parties, with substantial progress on both sides. However, as Yearn Finance, Curve, and Balancer have discovered, this is not sustainable.
However, each of the aforementioned advantages is just temporary. Yield Farming’s major goal is to increase its goods’ value by associating them with more precise and long-term benefits. With the expectation that it would eventually stop at Crypto and become a big global financial flow.
The Risk from Yield Farming
Yield Farming has significant risks that if participants do not fully aware of, they will have a very high chance of losing money.
Risks of smart contracts
The first risk appears in smart contracts. You know that small teams often develop these protocols, so the possibility of its bugs in smart contracts is very likely. The fundamental factor is a lack of funds to conduct the audit. Even with an audit, flaws can still occur, and valuables can be readily taken. Audited Protocols are still capable of bugs and stolen money, as in the case of Bzrx, Curve…
Risk of bubbles
Bubble risk is a matter of concern. When Compound launched liquidity mining, many things started to happen, leading to the risk of bubbles occurring in the DeFi community.
These projects often offer very high Coin APY (Annual Percentage Yield) levels, up to several tens to several hundred thousand interest rates, as well as many promises for the future for a tremendous amount of money. Almost all of us want to gamble like that, and getting into a scam project is very likely to happen if we do not know the game’s rules.
Impermanent loss occurs when you provide liquidity to the Liquidity Pool. Then the price of your deposited asset changes compared to when you deposited it – the more significant this change, the greater the temporary loss.
In this case, the loss means that the dollar value at the time of withdrawal will be less than at the time of deposit. Still, it should be noted that the temporary loss is only an actual loss when you withdraw your LP pair from the Pool.
However, the Impermanent loss can still be countered by transaction fees and the part of the token that can be farmed. In fact, pools on Uniswap that suffer temporary losses can also benefit from transaction fees.
Yield Farming has left a lot of impressions in the DeFi space, but there are hidden risks in it that you need to be aware of if participating in this market. Having that said, Yield Farming can be an innovative and attractive form of passive investment in the decentralized financial market. However, investors need to research it carefully, especially on the types of coins and the associated risks, before deciding to invest.
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