[Learn] The revolution of staking, Yield Farming

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In Part 3, We will discuss the core of the DeFi market, Yield Farming.
There is a lot of content related to “staking,” so if you read Part 2 together, you will be able to understand yield farming more easily.
We will discuss yield farming, which is the core of DeFi in the blockchain market.

[3] Yield Farming

What is Yield Farming?

With the appearance of the DeFi market, staking is further expanded to a service called “Yield Farming.”
Yield Farming refers to depositing cryptocurrency in a liquidity pool
(ref Part 1) of the DeFi AMM protocol to provide liquidity and receiving interest (a governance token) as a reward.
It refers to the process of staking a certain cryptocurrency to a DeFi protocol using a smart contract and receiving rewards (interest) at a variable interest rate. At this time, a user provides liquidity by pairing his or her two cryptocurrencies in a liquidity pool.

Yield Farming is also called “liquidity mining.”

- Liquidity Pool : It can be said that AMM is a safe that stores all cryptocurrencies supplied by users.

- Governance token : It is a token that holders have the authority to vote or influence decisions on the operation of a protocol.

Yield Farming in DeFi is an advanced system that applies staking functions to secure more stable”liquidity of cryptocurrency,” which was the cause of the failure of the first generation of decentralized exchanges.

What is liquidity in DeFi?

The core of DeFi, Liquidity

Liquidity is an essential factor in maintaining DeFi projects and the entire ecosystem sustainable.
In the initial stage of DEX, a development team was able to support the operation of an exchange, but the initial liquidity could not be artificially provided due to the relatively lack of capital.
As users’ trading volume has not increased due to insufficient liquidity, operating profits (transaction fees) decreased.
Therefore, there are restrictions on continuing project development.

The virtuous circulation of the decentralized exchange with stable liquidity.

Let’s take the DEX protocol mechanism as an example and assume the growth structure of the DeFi ecosystem with stable liquidity.

Open AAM (DEX protocol) service
→ Promoting the high interest rate by liquidity supply rewards
→ Supplying liquidity by users’ cryptocurrencies (staking)
→ Abundant liquidity and lower slippage
→ The growth of the amount of cryptocurrency transaction (swap) and the number of users using loan services
→ The growth of protocol’s revenue and the value of a governance token
→ The growth of user communities and promoting activities
→ Additional liquidity supply by new users
→ Providing new DeFi services (e.g.sale of new cryptocurrency)

- Slippage : It refers to the difference between the price at which the trade was executed with the expected price due to a lack of liquidity. In AMM, if the liquidity of cryptocurrency B is insufficient when exchanging cryptocurrency A to B, a user receives a lesser amount than expected.

Liquidity is an essential factor in the growth and expansion of a DeFi protocol, and securing stable liquidity is an essential condition for the success of a DeFi project.

The Feature of Yield Farming (compare to staking)

① Staking in a pair

: [Staking] Single cryptocurrency → [Yield Farming] Staking a pair of two types of cryptocurrencies

- Staking of PoS (Proof of Stake) based cryptocurrency is a single staking form of the blockchain cryptocurrency because the purpose is proof of staking in network operation.

- However, in the case of yield farming of the DeFi protocol, the liquidity pool is composed of pairs based on AMM’s decentralized transaction mechanism, “the amount of cryptocurrency A X the amount of cryptocurrency B = constant.” Therefore, a user must provide liquidity with a pair of cryptocurrency A and B to participate in yield farming.

② Higher APY (Annual Annual Yield)

- The interest range of PoS (Proof of Stake) based cryptocurrency staking is mostly 10 to 30 percent. (Currently, the average interest is about 10 percent)

- However, a yield farming DeFi protocol varies depending on the cryptocurrency pair to a user who provides liquidity, but it provides an average interest rate of more than 50 to 100 percent.

Liquidity providers share a certain amount of interest set as rewards at each moment, so if a user has preemptive effect by providing liquidity in the early stage after opening of a pool, he or she can earn high interest profit ( over 100% interest rate) in a short period of time.

However, be careful because the high interest rate may lead to dumping of interest supplies.

③ Easier withdrawal

- Staking of PoS cryptocurrency takes a certain period of time to receive when withdrawing (unstaking) assets, so it is inconvenient for users and market liquidity.

- However, in the case of a DeFi protocol, deposits/withdrawals are available immediately because it is a concept of providing liquidity of cryptocurrency transactions, not staking for network operation.

Contemplation of Yield Farming

Yield Farming has two biggest advantages for investors.

First, yield farming provides a high interest comparable to trading revenue. The amount of tokens provided as interest to the entire liquidity pool is constant, and users receive interest on the rate of liquidity they provided.
In the case of users who provided liquidity in the early stage of yield farming, daily yield farming revenue often exceeded 1 percent of the principal due to the preemptive effect.

Second, interest (yield) can be used in making profits through the market purchase or staking. A certain DeFi protocol provides additional profits to participants by re-staking a governance token earned from liquidity mining into the network.
This has the effect of reducing the supply of potential interest supplies to the market and encourages users who are providing liquidity to the DeFi project to provide liquidity with a long-term perspective than the initial expected supply period.

On the other hand, there are concerns.
For instance, Vitalik Buterin of Ethereum mentioned on Twitter, “Honestly I think we emphasize flashy defi things that give you fancy high interest rates way too much.
Interest rates significantly higher than what you can get in traditional finance are inherently either temporary arbitrage opportunities or come with unstated risks attached.”

Now, the DeFi market has passed through the introduction period and is in the middle of its growth period, a number of DeFi projects are coming up with improvement measures for a more stable yield farming system.
Recently, several “DeFi 2.0” projects (Olympus DAO, etc.) have been released that have secured stable liquidity, improved interest rates, and improved supply control measures for interest.
There are still many parts left to pass market verification as the initial test model, but it is worth looking forward to the fact that derivatives projects are being released one after another and total value locked (TVL) is steadily rising.

* TVL(Total Value Locked) : it is a total amount of assets deposited in liquidity in the DeFi market.

Change in the blockchain ecosystem by the DeFi market

① It has increased access to transactions or listing of new tokens.

In AMM (Uniswap, etc.) tokens created by individuals/corporations can be traded (listed) at any time.
For instance, Uniswap is an AMM DEX protocol that operates on the Ethereum network.
Therefore, tokens that follow ERC-20 standard that allows easy cryptocurrency P2P transactions.

This is AMM’s unique difference compared to the centralized exchange (CEX) with high hurdles (strict listing screening, listing costs) before tokens are traded.

This led to a virtuous circulation of “activating competent individuals or small start-up blockchain projects → Market growth/expansion of the ecosystem.”

② It played a major role in increasing the liquidity of the blockchain ecosystem.

In case, Bitcoin and Ethereum have many wallets with a large amount of coins, but they have been inactive for a long time.
The reason is that there was no use other than holding.

However, since the launch of yield farming in the DeFi market, a significant amount of cryptocurrency has begun to be transferred and traded from top-holding wallets to CEX or DEX, and the overall liquidity of the blockchain market as well as the DeFi market has continued to increase.

③ A new helper, emergence of a global cryptocurrency professional venture capital

When the new market gains public attention, funds flock. This leads to massive investments by several VCs, and when news of major VCs’ investments is released, the public interest grows again.
In other words, a virtuous circulation structure is formed to grow the market.

Total Value Locked (TVL), which means the total amount of assets deposited in liquidity in the DeFi market, has continued to reach a new high point since its launch in the year of 2018.
Despite the cryptocurrency market weakend, the entire DeFi TVL set a record of $154 billion in May 21, 2021.

To end

High interest rates, securing and maintaining stable liquidity, and supply control policies of interest volume are key points in DeFi, and it can grow soundly when these three are properly balanced.

To the end, a number of DeFi projects continue to research the next-generation of staking and yield farming systems in more diverse directions.

In addition to implementing a decentralized-based P2P financial system, the DeFi sector is likely to become a growth momentum for the blockchain ecosystem to establish itself as a new industry.
Therefore, please prepare for a new trend of change in the blockchain market that will come with constant interest and learning in DeFi.

In part 4, we will discuss past incidents in the DeFi field and introduce how to find promising DeFi projects.

Thank you for reading our post.🙏
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