What is Yield Farming in Decentralized Finance (DeFi)?

Did you know that you can make money from crypto by lending your crypto? Yield Farming is booming, and many crypto adopters are looking for a way how to profit from it. Be aware, almost 80% of the content on search engines will confuse you about yield farming in DeFi (decentralized finance), its importance, role, and benefits.

We have aim to briefly and describe each and everything about yield farming and benefits to crypto enthusiasts.

What is Yield Farming?

Yield farming is the process that focuses on gaining the highest yield and a way to make more crypto with your crypto. This emerging trend in the world of crypto has grabbed the attention of millions of traders.

Yield farming became popular since decentralized finance introduced protocols like Aave, Compound, and others. DeFi economy excessively grew in 2020 with a total lock value over $18B.

How does Yield Farming work?

It lends your funds to others through smart contracts. In other words, smart contracts are small computer programs that run a particular function.

While lending your crypto, you earn fees in the form of crypto in return for your offered services. Analytics have shown its favorable rate, which is quite better than in traditional finance. Now, yield farming is considered one of the most popular ways of generating rewards with crypto holdings. That’s how simple yield farming is.

Yield Farming-Working Scenario

Yield farming typically resembles AAM (automated market maker), which is a type of decentralized exchange (DEX) protocol. AAM involves liquidity providers (LPs) and liquidity pools.

Let’s analyze how it works.

In simple, a liquidity pool powers a marketplace, and the providers deposit funds into it.

Users are allowed to lend, borrow, or exchange tokens here, and usage of these platforms incurs fees to users, which are then paid out to liquidity providers according to their share of the liquidity pool. But the implementations may be vast and different.

The liquidity providers are required to deposit the funds into stable coins pegged to the USD. The common stable coins used in DeFi are BUSD, USDT, USDC, and DAI.

Some protocols mint tokens so your deposited coins will represent in the system. That’s how it works.

TVL-Total Value Locked

The TVL has excellent importance in yield farming because it’s a pretty good way to measure the overall health of your DeFi yield farming. TVL allows you to measure the amount of crypto locked in DeFi lending and other types of money marketplaces.

TVL called a useful index among providers because it aggregates liquidity in liquidity pools and perfects to measure the health of the DeFi and yield farming market as a whole. Moreover, it’s also an effective metric to compare the “market share” of different DeFi protocols.

Check a useful website www.defipulse.com, in order to track TVL.

It tracks key metrics for Decentralized Finance(DeFi) projects so you can stay up to date on the latest trends. You can check the platforms of the high amount of ETH or other crypto assets locked in DeFi. It is recommended to the yield farmer of the DeFi because it gives you a general idea about the current state of yield farming.

It has been said that the more value is locked, the more yield farming may be going on while the TVL can be measured in USD, ETH, or even BTC. But all of these will give you a different outlook for the state of the DeFi money markets.

Yield Farming- Returns Calculations

In general, the estimated yield farming returns are calculated annually. We can use two metrics, the Annual Percentage Yield (APY) and the Annual Percentage Rate (APR).

• Annual Percentage Rate (APR): The total amount of interest you pay each year. It doesn’t take into account the effect of compounding.
• Annual Percentage Yield (APY): The real rate of return you earned on a deposit of savings or investment. It takes into account the effect of compounding interest.

What is Compounding?

Compounding is the direct reinvest of profits to generate more returns or the process whereby interest is credited to an existing principal amount and interest already paid. In compounding, the terms APR and APY may be used interchangeably.

But one thing, the short-term rewards are difficult to estimate accurately with ARP or APY calculations because these are the estimations only. On the other hand, yield farming is a fast-paced market with a lot of competitors. In this field, the rewards can fluctuate randomly and rapidly. Some strategies work, maybe some not.

Both of these terms have come from legacy markets; DeFi may need to find its metrics for calculating returns. As you know, the DeFi is fast-paced. Therefore weekly or even daily estimated returns may make more sense.

Yield Farming- Platforms and Protocols

The yield farming strategies may change by the hour while the different platforms are tackled with their own strategy, rules, and risks. If you have decided to get started with yield farming, you must get familiar with how decentralized liquidity protocols work so you can face future difficulties.

Above, we already explained the basic idea. But implementations can vary greatly. No one generally deposits his hard-earned funds and hope for high returns. You should need to remain in control of your investment. So, here we describe the most popular platforms, which are a collection of protocols and core to yield farming strategies. You can trust them.

MakerDAO

MakerDAO is the decentralized credit platform in yield farming that highly supports the creation of DAI stable coin, which is algorithmically pegged to the value of USD. Users can open a Maker Vault and lock collateral assets, such as WBTC, BAT, USDC, and ETH, and can generate DAI stable coin as a debit against this collateral that they locked.

Most of the yield farmers use Maker to mint DAI to use in yield farming strategies.

Aave

Aave is a perfect decentralized protocol for borrowing and lending. The good thing about this platform is the interest rates are adjusted algorithmically, based on current market conditions. Here are “aTokens,” which lenders get in return for their funds. These tokens are boosted to start immediate earning and to compound interest upon depositing.

Moreover, flash loans are also offered by the Aave, which is considered as advanced functionality. Such features made Aave one of the heavily used platforms by yield farmers.

Revolution of DeFi and Yield Farming

We have taken a look at the trending craze of yield farming in decentralized finance. The revolution of blockchain technology and DeFi brings new applications and may spring up components built on these current components in the future.

With this growing development, DeFi products are definitely booming in various marketplaces like crypto-economics and other money markets, etc. These can help create a more open and accessible financial system available for anyone with just an internet connection.