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What is DeFi Yield Farming? – An Easy to Follow Guide for Beginners 

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What is DeFi Yield Farming

The introduction of the DeFi sector has brought along a lot of hype surrounding its new products and features. One of these features that have become commonplace amongst the industry is DeFi Yield Farming. This unique protocol allows new users to earn a passive income with very little understanding of the market conditions and cryptocurrencies in general. For these reasons, DeFi yield farming is one of the fastest-growing crypto investment sectors in the market.

DeFi yield farming or staking allows individuals to earn tokens in exchange for their participation in DeFi applications. Currently, users can stake stablecoins, such as Dai, USDT, or USD Coin, along with endless platform governance tokens. It’s also possible to yield farm using cryptocurrencies such as Ether as most platforms reside on the Ethereum blockchain at this moment.

What Problems Does DeFi Yield Farming Attempt to Fix?

DeFi yield farming attempts to correct a few major issues plaguing the market at this time. Primarily, yield farming provides new crypto users an easier alternative to earn a passive income. Compared to trading cryptocurrencies, yield farming requires less understanding and effort. In this way, yield farming provides a more secure alternative to trading cryptocurrencies without experience.

COMPOUND

COMPOUND

How Does DeFi Yield Farming Work

Every platform has its own technical specifics regarding its yield farming strategy. As such, you will need to invest a little time to better understand the benefits of each platform such as its lock-up periods and return rates. However, in general, the most common yield farming method requires you to lock your cryptocurrency into a liquidity pool smart contract.

Depending on the platform, the liquidity pool could serve multiple purposes. Your liquidity could be locked in a public pool that allows users to borrow the funds with interest. This interest also goes back to the fund to gain more rewards. In the end, this strategy creates a profitable loop for savvy investors.

There are also liquidity pools that provide funding to projects in the market. In this scenario, you receive rewards for helping to bolster a particular project’s liquidity. This is the most common type of yield farming at this moment. It was also the original strategy envisioned by developers in the space.

Benefits of DeFi Yield Farming

There are a lot of benefits to DeFi yield farming. For one, investors gain access to larger ROIs with less effort using this approach. Early bird investors benefit the most because they earn rewards and benefit from the appreciation of the token during launch. Commonly, investors will take these profits and reinvest them in other DeFi projects to farm yet more yield.

Interoperability

The entire DeFi sector is built around interoperability that makes the market extremely versatile. Some platforms take your staked crypto and bounce it from platform to platform automatically. All of this interoperability improves investors’ returns and provides more options for users. It’s common for experienced investors to stack protocols to leverage profits further.

History of DeFi Yield Farming

The history of yield farming begins in the summer of 2020. this is the time that COMPOUND first introduced the service to the market. COMPOUND’s strategy was to offer users a small share of transaction fees for contributing liquidity to a particular application. In this instance, COMPOUND started with pools on Uniswap or Balancer. Both services proved to be hugely successful.

DeFi Liquidity Locked Via Coindesk

DeFi Liquidity Locked Via Coindesk

This success caused a waterfall of copy cat platforms to enter the market. Additionally, some high-end platforms also entered the space and expanded on the yield farming concept. These platforms introduced features such as associated governance or native tokens. The platforms also began rewarding users with native tokens rather than ETH.

Advanced Yield Farming

Due to the interoperability of the sector, and the quick introduction of new and exciting farming methods, there has been an emergence of advanced yield farming tactics. These users will stake tokens in a chain of protocols to generate maximum yield. These advanced staking methods produce unmatched ROIs but are very complex to the average user.

Risks of DeFi Yield Farming

Yield farming is exciting but comes with a variety of risks that one must consider before they invest. Primarily, if you want to earn a large reward for your farming efforts, you will need to put down a large value of initial capital. This raises your risk exposure.

Pure Speculation

Additionally, the highly volatile nature of  DeFi tokens poses another concern. Most DeFi investors are purely speculative at this moment. They intend to resell their token at a later date for profits. The problem with this group of investors is that they often display shaky hands.

Speculative investors are quick to sell their holdings during market downturns. These sales can lead to a cascade of other investors joining in. Eventually, you end up with a run-off sale that obliterates the platform’s value and leaves investors suffering.

A perfect example of this occurring is when Hot Dog Swap saw major losses this year. In the incident, the market suddenly dropped and left investors holding the bag. Specifically, Hotdog dumped 99.9% of its value in just a couple of hours after launch.

Coding Risks

Coding risks are another issue that investors should consider. Many of these platforms are not open-source. That means that the coding was not vetted by the community. When a project’s team and underlying smart contract codes can’t be vetted, it raises the risk level significantly. The DeFi sector is booming and developers constantly bootstrap projects from scratch or copy the code of their predecessors. Losses occur whenever the code is unaudited as bugs and attack vectors are discovered by users and hackers rather than developers.

A perfect example of how faulty coding can cost investors occurred with YAM Finance. A line of bad coding caused mayhem for this startup. Specifically, the platform saw its utility token jump to $57 million in value in just two days due to coding errors. This growth was an obvious coding error. Later investigation revealed a plethora of coding and security concerns with the platform.

DeFi Yield Farming – What the Future Holds

The DeFi sector appears to be well on its way to cementing its position in the market. However, much like the ICO boom of 2017, investors need to DYOR before they venture into this market. If done correctly, DeFi yield farming is a great way to earn some free crypto. However, your success will directly depend on your ability to assess a platform’s validity accurately.

David Hamilton is a full-time journalist and a long-time bitcoinist. He specializes in writing articles on the blockchain. His articles have been published in multiple bitcoin publications including Bitcoinlightning.com

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