DeFi 101: Yield Farming Explained

If there’s one term that’s most associated with DeFi, it’s “yield farming.” The term encompasses a variety of strategies that are all about making your money work for you. This is done by “farming,” or accumulating, the best yield across many different protocols within DeFi.

So, how does one become a “yield farmer”? Let’s talk about what it takes to maintain your farm and keep your yield harvest healthy.

Tending to Your Farms

Yield farming demonstrates some of the best aspects unique to DeFi. To get started, you’re going to have to get accustomed to the various protocols in the ecosystem: from decentralized exchanges to lending protocols to staking and more. All of these provide yield on your precious coin, thus letting you collect that harvest and compound it.

That being said, most yield farmers got their start by providing incentivized liquidity, colloquially called “liquidity mining.”

Back when DeFi was just getting started in 2020, many protocols like Yearn took the innovative first step of bootstrapping their liquidity through farms. This meant that users could provide liquidity, stake the liquidity tokens on the protocol, and earn some of the protocol’s governance token. Often, the APY was very enticing.

Providing liquidity already earns you a healthy amount off of trading fees — but if you keep an eye out, you can still commonly find new protocols bootstrapping their liquidity by offering extra incentives. Protocols are known to entice deposits from users with high APY in their native token. These are commonly called “farms.” And that’s prime real estate for a farmer.

The most common decentralized exchanges used for farming incentivized liquidity are Uniswap, PancakeSwap, Sushiswap, and 1inch.

But of course, there’s significant risk. A new project could suffer from a smart contract bug or, even worse, it could rug pull — which is when the project pulls its liquidity. Always be wary of projects that are anonymous, especially if they have no reputation.

Farms were once “wild west,” sometimes offering 4–5 digit APY for providing liquidity. Today, the market is not as frothy as it was then. Still, yield farmers can find healthy opportunities by providing liquidity in the current market. These days, farming has become more sustainable.

Other Ways to Yield Farm

Chasing high-digit APY is not the only way to yield farm. Some farmers opt for more conservative strategies.

For example:

• You can use AAVE or Compound to deposit stablecoin or a major cryptocurrency to earn yield. The protocol lends out your tokens to other users and you earn a portion of the interest.
• Sometimes, other chains offer incentives to use their network. Optimism, for example, often incentivizes protocols on their chain using their native OP tokens. This can be a prime opportunity to yield farm.
• Staking offers another option for yield. For example, you can now stake ETH, providing an easy way to earn. That staked ETH (stETH) can also be utilized in other DeFi protocols, for example, as collateral for a loan.

These are some of the basics, but things can get quite complicated if you are looking to experiment.

For example, you could take out a loan on AAVE and then use that loan to farm a token that you think has potential. The complexity can go even further — nowadays, you can long and short tokens on-chain, which means you could compound yields by margin trading. But keep in mind, this can get incredibly risky and is not for the faint of heart.

Go Forth and Harvest that Yield

If you’re just getting started tending to your harvest, your best bet is to begin by providing liquidity. If you spot a protocol offering susinstable APY (~20–50%) by incentivizing its liquidity, then it may be a good idea to dip your toes in and start earning some yield.

You should familiarize yourself with the leading DeFi tools, so you can better keep track of your earnings. The most common ones include Zapper — which allows you to “zap” your liquidity-pair into an incentivized farm in just 1 click — and DeBank which is an all-purpose dashboard for DeFi.

Of course, one yield farming protocol that hasn’t been mentioned yet is… Vesper! Vesper provides you with yield in the token of your native deposit, plus you earn some VSP governance token. Someday, Vesper hopes to be the leading spot for all the yield farming newcomers.