DeFi and Yield Farming — Everything You Need to Know


1- Burn of Ownership Key: the creator of the project must burn the ownership key making the project ownerless (not sure if that’s a word)

2- No pre-mine, fair lunch: since the governance tokens will be used for governing the protocol, the governance tokens should be distributed fairly with zero pre mine.

3- Community Governance and Voting: Any changes to the protocol must be voted by the community

If a protocol has the characteristics above, every single aspect of the protocol is distributed across many people and countries with no single point of failure.

DeFi stands for Decentralized Finance. It has become a buzz word that a lot of people throw without knowing what exactly it means. DeFi is the movement to remove the middle man and give the financial gain opportunities back to people. While DeFi is only name of the movement, there are a suite of products that forms the ecosystem. There are DEXs (decentralized exchanges) like Uniswap, there are lending and borrowing platforms like LEND and COMP and there are automated yield farming protocols like YFI. We will dive deep into each of them and how they play a role in DeFi space. All these projects have a few things in common. One, they are decentralized meaning that there is no owner and the project is open source running as a smart contract. Two, they pass the profits a middle man would generate onto the people who supply liquidity to the projects. The protocols are not built to generate profit but only to help the space become more decentralized. So, essentially you become your own bank. Let’s start from lending and borrowing and we will build on from there.

Lending and Borrowing

DEXs and Automated Market Making

Concept of Yield Farming

However, do not let that discourage you! Because there are protocols who have automated the entire process and all you have to do is deposit funds on the platform and let the smart contract automate the entire process saving you time and gas fees. An example would be Yearn Finance (YFI). You can deposit stable coins to Yearn and let the protocol farm the pool that has the best returns. You always get exactly whatever you put in and plus some interest. There is no impermanent loss here. The current strategy on YFI is farming Curve with stable coins and selling the Curve for stable coin.

If you are a little bit savvier, then you can manually farm protocols that offer LP incentives. As an example, let’s look at FARM. Harvest.Finance is truly decentralized automated yield farming protocol (Don’t let the troll look trick you).

Harvest utilizes the same farming strategy as YFI but it also provides an incentive for providing liquidity in their pool by offering $FARM tokens. FARM is the governance token of Harvest just like YFI to Yearn. Though, YFI supply is maxed out and it can’t be farmed, Farm can currently be farmed. No pun intended. Then you can use your FARM in staking FARM pool and farm more FARM.


Impermanent Loss

Now that you have made this far, you probably want some example protocols to look at. I will list a few with their potential and risk measures.

Yearn — vaults are the safest way you can earn interest on your stable coin

Harvest — is another protocol that let’s you farm their governance token while deploying the same farming strategy as yearn

YFV, LUA — and are both protocols that let’s you deposit uniswap liquidity provider tokens and farm their governance tokens. Though, these protocols have high risk of incurring impermanent loss.

Don’t Get Rugged!

As a DeFi movement participant, you don’t want to get rugged. So, how do we avoid it?

Here is my checklist and reasoning of why a protocol must have the following.

· The smart contract has been audited by a REPUTABLE COMPANY. More the marrier. This will make sure that no one can steal your funds from the smart contract. So, you can minimize the smart contract risk.

· Check out their website or ask the community, if the ownership keys have been burnt and whether the project is governed by community voting. This will ensure that the developers can’t mint more tokens or change vital aspects of the protocol.

· Ask if there is any time lock on the farming strategy. All automated farming protocols use a strategy, most common ones are farming CRV or COMP or BAL. You want the protocol to have a timelock on the strategy. If the developers want to change the farming strategy to a risky project, you want to have the time to consider and chose whether you want to be part of that strategy or not.

· Check if the community is active and legit. Read their medium posts, look at their telegram, twitter. See if their medium posts are well thought and written, how often do they update the community.

· Not a requirement but good to see though its quite rare. If the team is transparent and show who they are rather than an anonymous team of developers. It just adds more liability on them and shows intention. That being said, this doesn’t make it bullet proof. Google Carlos Matos.

· If you are an LP in Uniswap, look at both contracts for the pair you are providing liquidity. Check if the pair has healthy volume to liquidity ratio. If a coin has more volume than liquidity that usually means its either new or they are about to rug everyone. Most importantly, check the contracts and the holders of the coin. If there are wallets with big percentage of the supply, rug is about to be pulled.

Final Thoughts — Is this all a scam? Is this a bubble?

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