This article will explain the basics of yield farming and how you can earn from it.
In the past few years, Decentralized Finance (DeFi) has become one of the most important areas in the field of cryptocurrencies, while yield farming is one of the key ways traders make money in this segment of the crypto market. Indeed, yield farming can be very profitable with returns ranging from 10% to 50%.
However, there also exist some risks which users should be aware of before engaging in yield farming.
Yield Farming
So, how does yield farming work?
Put simply, yield farming occurs when you provide a DeFi project with funds, thus giving it liquidity. In addition to the standard commission deductions, you also receive (“farm”) project tokens as a reward for doing so. These tokens have their own value, which can grow over time, thus increasing the return on your investment.
As a result, both parties benefit from this exchange – you earn profit, while the project you’re supporting raises funds and motivates users to invest in liquidity pools.
Liquidity Pools
A liquidity pool is a mechanism by which decentralized exchanges obtain liquidity. Investors upload their funds into liquidity pools to enable the operation of the project.
Yield farming is characterized by having two pools:
• Pool 1: this differs from the standard DEX liquidity pool in that it has only one asset, which means there is no trading pair. You deposit only one token and get rewarded in one token. For such pools, there is no risk of intermittent losses, but profitability is much lower than for pools with two assets.
• Pool 2: these often consist of a native project token (governance token) and a second underlying asset. Such pools create and maintain project liquidity.
Usually, you can easily distinguish one pool from another solely by looking at its name. If it has one token ticker, for example, just UNI, then it is pool 1. If the name is written using a slash, for example, UNI / ETH – this is a trading pair and thus relates to pool 2.
Native Tokens
A governance token, also referred to as native token, plays one of the key roles in yield farming. Their price directly depends on the success of the project. Such tokens have strong volatility and are subject to significant price fluctuations.
This is an important feature of native tokens. In the early days of income farming and DeFi, many pioneer project tokens had a low value and were distributed among farmers. Those who did not sell immediately, but saved these tokens for the future, were later able to earn much more than expected from their growth.
In profitable farming, it is important not only to farm tokens, but also to sell them at the right time, which gives users an opportunity to earn profits from arbitrage. Although making profits that way might seem confusing at first, in reality it is a lot simpler– especially now, when you can easily find a high-quality crypto arbitrage scanner.
A good way to get started on crypto arbitrage is to visit the OTC crypto trading platform to find out more about crypto arbitrage, as well as to engage in real-life practice.
How To Make Money On Yield Farming
One of the most popular ways to earn profits from yield farming is to provide liquidity for various projects. That way, in addition to earning commissions in the liquidity pool from each completed transaction in proportion to your share in the pool, you also receive additional income in the form of native tokens, LP tokens, (where LP stands for liquidity pool).
LP tokens are credited to your wallet immediately after you have invested in the pool, their amount depends on the amount of funds you deposited. They entitle you to ownership of your funds in this pool and you can use them to withdraw your funds. But you can also freely dispose of LP tokens at your discretion. For example, invest them in another pool.
Also, liquidity pools for profitable farming do not always have the ratio of 50/50 for two assets, as is usual for conventional DEXs. For instance, it could be 98/2 and in fact any ratio of assets, and the amount of assets in one pool is practically unlimited. Such pools can consist of different ratios of several assets at once.
Closing Thoughts
Yield farming is a relatively new, but an extremely fast-developing concept, as it allows for almost anybody to multiply their income without leaving the comfort of their own home. It opens a wide range of opportunities not just for advanced crypto users, but also for beginners who are just getting into the world of cryptocurrencies.
This may sound attractive, but always remember to do your research about the project before investing funds into it, as there will always be some level of risk.
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