Yield Farming? DeFi ? What is it?

Yield Farming is one of the most popular concepts in the world of decentralized finance and has taken the entire industry by storm.

It compensates investors for securing their crypto assets in a (DeFi) decentralized market. Lets take a deep dive into yield farming and its components, as well as its appeal to investors and potential hazards.

What is Yield Farming?

Yield Farming is a method for cryptocurrency holders to receive incentives on their investments. An investor uses yield farming to deposit units of a cryptocurrency into a lending protocol in order to receive interest from trading fees. Some users receive additional rewards from the protocol’s governance token.

Yield farming operates in the same manner as bank loans do. When you borrow money from a bank, you must repay it with interest. Yield farming works in the same way, except this time the banks are cryptocurrency holders like you. Yield farming employs “parked cryptos” that would otherwise be waste away in an exchange or hot wallet to offer liquidity in DeFi protocols such as Uniswap, Pancakeswap or Sushiswap in return for a profit.

Automated Market Makers, Liquidity Pools, Liquidity Providers

Yield farming is used in conjunction with a liquidity provider and a liquidity pool (a smart contract containing cash) to fuel a DeFi market. An investor that deposits funds into a smart contract is known as a liquidity provider. The liquidity pool is a cash-filled smart contract. The automated market maker (AMM) concept is used to perform yield farming activities.

On decentralized exchanges, this concept is ubiquitous. The traditional order book, which contains all “buy” and “sell” orders on a cryptocurrency exchange, is replaced by AMM. An AMM generates liquidity pools using smart contracts rather than declaring the price at which an item is intended to trade. These pools carry out transactions according to predefined algorithms.

The AMM concept is highly reliant on liquidity providers (LPs), who deposit money into liquidity pools. These pools serve as the foundation for most DeFi marketplaces, where users may borrow, lend ,trade, and swap crypto tokens. DeFi customers pay trading fees to the marketplace, which distributes the money to LPs Liquidity Providers depending on their liquidity share in the pool.

USDT, USDC and DAI, are some of the most popular DeFi-related stablecoins. Some protocols can also create tokens that reflect the coins you’ve put in the system. For example, if you invest Celo Dollars into Ubeswap you will receive UBE.

How to Calculate Yield Farming returns

Estimated yield returns are determined using an annualized model. This calculates the potential earnings from storing your cryptos for a year.

Annual percentage yield (APY) and annual percentage rate (APR) are two of the most used measures (APR). The major distinction between them is that APR does not take into account compound interest, which entails reinvesting earnings to enhance returns.

The majority of estimates models are simply approximations. Because yield farming is a volatile industry, calculating profits on yield farming is challenging. The market is highly volatile and hazardous for both borrowers and lenders. A yield farming technique may produce great returns for a period of time, but farmers may adopt it in large numbers, resulting in a decline in profitability.

ALL in ALL

In return for profits, Yield Farming leverages investor capital in order to generate market liquidity. It has considerable development potential, however, it does have its flaws.

Do your research and stay safe out there!

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