‘Yield Farming’ for Dummies
Yield farming lets crypto investors exchange, borrow, lend, and stake their tokens while earning passive interest. The practice of yield farming is powered by DeFi, which stands for decentralized finance.
Yield farming across DeFi works through smart contracts, which automate financial agreements between you and another party. Smart contracts carry the advantage of “self-executing” on the blockchain after the agreement’s terms have been met.
Smart contracts also permit software developers to create decentralized applications, known as DApps. To begin yield farming, investors must add their own tokens to decentralized exchanges.
These decentralized exchanges send your tokens to liquidity pools, which are smart contracts that contain popular coins from other investors. Once you’ve assumed the risk of “locking in'' your assets, you’ll take on the role of a liquidity provider. Based on the liquidity they lend to decentralized exchanges, liquidity providers receive the exchange fees charged to other users.
Yield farmers can also lend their crypto to borrowers through smart contracts. As borrowers pay back their loans, yield farmers reap the interest fees stipulated in their smart contract.
Yield farmers can exchange one token as collateral for a loan of another, emerging token. This practice allows farmers to keep their existing assets while they earn yield on their borrowed coins. Borrowers take the gamble of making more profit than they pay in interest.
Additionally, farmers can earn passive interest from “staking” their cryptocurrency. Users of DApps are paid to lock their coins into the platform.
The validators who process and verify transactions along the blockchain must risk their assets, although they can reclaim their crypto whenever they want. Validators are paid interest fees for their maintenance efforts, but they incur small financial penalties for making mistakes.
Validators who don’t have enough money to meet “proof-of-stake” requirements can pool their assets with other DApp users. This is called a staking pool.
Although validators are chosen at random, payments for processing transactions are distributed to each member of a validator’s staking pool.
Finally, farmers looking to earn yield twice over can re-stake the tokens they receive from supplying decentralized exchanges with liquidity. This practice allows farmers to passively earn exchange fees in the form of LP (liquidity pool) tokens.
If they choose to re-pledge these tokens, they can earn additional interest fees as they validate transactions across the blockchain.
To yield significant returns on your stake; you’ll have to be an early adopter of successful farming strategies. While farmers who bring a larger amount of capital to the table risk a greater percentage of their assets, they possess much more leverage to create profit.
You should have experience with crypto and learn to mitigate risk before buying into new tokens or staking your existing assets with DApps.
