Blockchain technology and cryptocurrencies have become the next big thing as more companies start accepting digital currencies to enhance efficiency, transparency, and speed of transactions. Cryptocurrencies are also seen as investments. Imagine a person who bought 100 Bitcoins when they were less or about $1 in 2009 is now enjoying more than 42,000%. Incredible, isn’t it? With this kind of growth and popularity of cryptos, most people quickly ask, “How can I get more coins?” One of the answers is Yield farming, and we are going to take a deeper look.
What is Yield Farming?
Yield farming became a hot topic in the summer of 2020. So, what exactly is yield farming in decentralized finance (DeFi), and how does it work? This is a process of staking or lending your crypto coins to generate some rewards in the form of other cryptos. Although it is an innovative and risky undertaking, its demand has skyrocketed as more people target to grow their crypto portfolios. Indeed, yield farming has become one of the biggest drivers of the growth in DeFi, pushing the market cap to about $10 billion in 2020.
To put it differently, yield farming protocols help to provide incentives to liquidity providers (crypto owners) to take the risk of staking their coins using smart contacts. The incentives that liquidity providers get can take a number of forms, including: Transaction fees.
Interest paid by crypto coin borrowers.
The payments are given as annual percentage yield, and the most preferred coins are the stablecoins, such as DAI, USDT and USDC. Notably, most DeFi protocols are now built on the Ethereum network and reward liquidity providers with governance tokens for helping with liquidity mining and securing the network.
Yield Farming: How does it Work?
Now that you know what yield farming is, how exactly does it work? Its operation is closely related to how automated market makers (AMM) operate. Here, liquidity providers deposit their coins into liquidity pools, which are in return used to lend, mine, or exchange tokens.
Every transaction incurs a fee, which is paid to liquidity providers based on the percentage of the coins they have on the pool. Because this type of farming is relatively new, it is expected to intensify in the coming years. However, the bottom line is that liquidity providers get paid for the coins they commit to the pool.
Returns in Yield Farming: What Should You Expect?
“How are yields calculated in yield farming?” “How much should I expect after staking my coins?” These are the questions that keep running through the minds of crypto coin owners. Typically, the yields that liquidity providers get are calculated on a yearly basis. The most common types of metrics used to calculate the return are the Annual Percentage Rate (APR) and the annual percentage yield (APY).
The primary difference is that APY factors compounding while APR does not. Compounding is the direct investing of the generated profits to earn additional revenue. Again, this depends on the rules of the protocol, and it is important to try and understand before joining any pool. In 2020, some of the DeFi platforms recorded very high returns, reaching up to $40,000 in value at one stage.
Yield farming can be a complex and high-risk financial undertaking for both borrowers and lenders. When based on Ethereum, the most preferred platform, it is always subject to Ethereum gas fees, and it is important to get your expectations right. The best idea is to commit only a certain proportion of your cryptos and work with a reliable and trusted DeFi platform. Reach Mantra Dao now for assistance with yield farming. Let an expert hold your hand to increase the chances of optimizing returns on investment.