Yield Farming And Why You Need To Know About It
Have you heard recently about yield farming? You don’t have to be passionate about blockchain technology to get informed about these new buzzwords coming from emerging technologies. Yield farming refers to the process of utilizing decentralized finance (DeFi) to make the most of returns. Users can lend or borrow crypto on any of the DeFi platforms and in return, earn crypto for their services.
Those yield farmers who are seeking to increase their yield output can employ more advanced tactics. For instance, they can continuously shift their cryptos between various loan platforms to maximize their gains. Yield farming enables investors to earn yield by putting coins or tokens in a DApp, or decentralized application. Most common examples of decentralized applications include crypto wallets, decentralized social media, decentralized exchanges, etc.
Most yield farmers will typically use decentralized exchanges (DEXs) to lend, stake, or borrow coins to earn interest, while also speculating on price swings. Across DeFi, yield farming is simplified by utilizing smart contracts, pieces of code automating financial agreements between two or more parties without the intermediary.
Yield Farming Types
There are many types of yield farming you should consider if you’re interested in it. One of them is a liquidity provider, in which users deposit two coins to a decentralized exchange to offer trading liquidity. They are charged a small fee to swap two tokens by liquidity providers. Another one is lending, in which coin or token holders lend crypto to borrowers via smart contracts and earn yield from the loan interest. Similar to lending, we have borrowed, in which farmers use one token as collateral and receive a loan from another. This allows users to farm yield with the borrowed coins.
When it comes to comparing yield farming vs staking, we need to keep in mind there are two types of staking. One is on the proof-of-stake blockchains, while the other one is to stake LP tokens by supplying a decentralized exchange with liquidity. The reason why many users perform this option is that it allows them to earn yield twice.
Calculating Returns in Yield Farming
Usually, expected yield returns will be annualized, while the prospective returns will be calculated over a year. The most commonly used measurements to calculate yield farming returns are annual percentage rate (APR) and annual percentage yield (APY), however, the annual percentage rate doesn’t account for compounding, only annual percentage yield does.
Yet, it is important to keep in mind that both of these measurements are not accurate, but are instead projections and estimations helping you be more successful with yield farming. Not only long-term advantages are challenging to predict with accuracy, but also short-term ones. The reason for that is simple, yield farming is a very competitive, fast-paced field with dynamically changing incentives.
If your yield farming strategy works well, other farmers will try to take advantage of it, leading to stop yielding significant returns. Because both APR and APY are outdated market metrics, DeFi has the challenge to construct its new, unique profit calculations. However, they shouldn’t be focused on providing annual estimations, but weekly or daily due to frequent changes in this rapidly changing environment.
Best Yields on Layer 2
Those who are quite experienced in layer 2 crypto probably already know about valuable opportunities to earn yields on L2s. The reason why this approach is something you must consider is it allows you more gains. With L2s, APYs are not diluted and offer a double-digit return in numerous cases.
Also, L2s are much cheaper than other alternative solutions. Those who are tired of aping hundred dollars into a 69% APY pool and then losing the profit when depositing and withdrawing the money will surely appreciate this advantage. Another thing that gets yield farmers excited is the announcement of tokens which will unlock an entirely new range of opportunities.
Yield Farming Predictions
With most popular yield farming platforms, such as PancakeSwap, Curve Finance, and UniSwap, noticing an increase in their number of users, it’s safe to say that yield farming is not going anywhere. When it comes to estimating its profitability, the answer will depend on many factors, just like with everything else around cryptocurrency and blockchain.
Undoubtedly, yield farming can help users earn 1,000% APY, but it is also a risk many are simply not willing to take. The lack of accounting for cryptocurrency’s volatility is one of the main reasons why those who know all about yield farming are still hesitant about it. Users are also concerned about frauds and rug pulls, which some users have already experienced in their yield farming activities.
Whatever your decision is, keep in mind that you will need a lot of knowledge and experience to earn from yield farming. That is why many individuals seek blockchain advisory services from companies that have established themselves as leaders in this market and have achieved significant results.
This article is not financial advice, always do your own research.