What Is Yield Farming?
DeFi produces a new concept that can change the way investors HODL
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The last decade took us on a crazy crypto ride that disrupted whatever came its way. The DeFi boom became the premier talk of the town, whose viability ballooning to $4,000,000,000 in total value locked in DeFi (TVL) and a starting market cap from $500 million to $10 billion in 2020. The power of decentralized finance continued to transform legacy financial instruments into trustless and transparent platforms such as lending and borrowing services, insurance, and exchanges. And amidst the volatility of the crypto space and decentralized finance rose what came to be known as Yield Farming.
So, what is Yield Farming?
Yield farming is the earning of rewards by staking ERC-20 tokens and stablecoins into exchanges to stabilize the growth of the DeFi ecosystem. Otherwise known as liquidity mining, yield farming allows yield farmers to deposit or lend their idle cryptocurrencies within a mining mechanism, injecting the mining pool with digital assets that will accrue interests to lucrative heights. While similar to the concept of staking, yield farming surfs from market to market scouting for the ones with top yields. Yield farmers, or liquidity providers, are usually required to lock up their crypto assets in a smart-contract-based liquidity pool. They are, in turn, incentivized through a percentage in transaction fees, interests from lenders, or a governance token via liquidity mining. The said returns are cumulatively called annual percentage yield, or APY. The more funds are injected into the liquidity pool by yield farmers and liquidity providers, the higher the value of the issued returns becomes.
Is Yield Farming Risky?
As with all kinds of investment, yield farming associates with it its own risks. The complexities of yield farming alone offer risks to the borrowers and the lenders. The required investment, to be of value, must run to thousands of dollars subject to high Ethereum gas fees. The volatility of the crypto market can cause price slippage and impermanent loss. It can also be targets of hackers and fraudsters who are apt to find smart contracts that are vulnerable enough to be secured due to stiff competition that quick entries are left unaudited.
Defi protocols perform without intermediaries and, therefore, must function flawlessly in automation via applications. Any malfunctioning can unduly compromise investor capital and can impact the ecosystem. Losses are permanent and there is no way it can be undone since the blockchain structure is by nature immutable. Users are strongly advised to take their research seriously before embarking on this high-risk, yet highly rewarding investment phenomena.
Can I Profit from Yield Farming?
Any investor would ask the question to any venture before entering. And they would ask the same with yield farming. Yield farming may reap you rewards by lending your assets in the liquidity pool, but the profitability coming from it is still a topic for discussion.
As standard, the returns from yield farming are calculated on an annual basis. But it depends on many factors affecting it so that we can come up with more precise analytics. Yield farming profitability can be unpredictable as it depends highly on how much capital you have invested, the strategies you are using, and the liquidation risks incurrence to your collateral. Nevertheless, since yield farming is still in its nascent stage, any risk-taking investor can be rewarded with substantial returns. Even when profitability cannot be nailed yet, yield farming techniques are constantly being developed that not so few testify to the fact that their ROIs are 100 percent. It is not far that with DeFi’s unstoppable growth, expect yield farming to be the crème-de-la-crème among investment instruments.
What Metrics are Used to Calculate Yield Farming Profits?
First is the APR, or annual percentage rate without the compounding consideration. The calculation, instead, applies the multiplication of the periodic interest rate with the number of periods in a year. The annual return rate is then imposed upon the borrowers but is earned by capital investors.
The second is the APY or annual percentage yield in which the return rate based on the APY is imposed on borrowers and paid to liquidity providers instead of investors. Here, the compounding interest applies to provide returns to investors.
Decentralized finance has brought out the new concept of yield farming which has taken the digital financial world by storm and has already attracted millions of users to its fold. It allows you to earn passive income via the DeFi money lego system built on the Ethereum infra. You need not let your digital assets sit idle on your wallets but, instead, get them to work for you via yield farming.
The idea of HODL might just change anytime soon.
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