What is Yield Farming and how to get started with it?

In the world of web3, Decentralised Finance (Defi) can be regarded as one of the most important things that has ever happened. For a layman, Defi essentially means conducting all the financial activities without the involvement of any middlemen such as a bank. And one such application in the world of Defi is Yield Farming. 

As the name suggests, yield means to produce and farming implies an activity of growing, mainly crops, but here it means money. So, yield farming is an investment strategy used by traders and investors to grow their crypto assets i.e generate returns from their holdings. It is very similar to the world of web2 where we deposit our money in the bank’s savings account and earn interest thereon. 

To understand this, we would first need to understand the parties involved in the transaction. 

1. A user providing the crypto assets - known as Liquidity Provider(LP)
2. A platform receiving the assets to generate returns - is known as the Liquidity Pool. A liquidity pool is a smart contract that locks up cryptocurrencies and funds. 

Once a user has deposited their tokens in the pool, they are rewarded with a fee/ interest by the platform on which the liquidity pool is being hosted and hence it becomes an income-earning opportunity.

The pool acts as a marketplace to allow users to borrow and lend funds at a cost. Yield farming is mainly done on the Ethereum network and users get paid in ERC-20 tokens which are supported on the Ethereum blockchain. 

Growth Opportunities with Yield Farm

Started in 2020, yield farming as an investing opportunity is growing manifolds. Some of the best yield farming platforms are -

Uniswap

Uniswap is one of the leading decentralized exchange platforms that also provides the option of liquidity pooling. More than $5 billion is locked on the platform which helps users generate returns of 20-40% APR. The platform accepts all the ERC-20 tokens. For every trade, the platform charges 0.30% of fee which is added back to the pool. 

Aave

Aave is one of the leading Defi protocols that helps users to earn on their crypto assets. The total value locked on the platform is over $10 billion. A user can easily earn 4-8% interest APR on their holding via liquidity pools. The platform charges 0.09% fee which is in turn provided to liquidity providers as a part of incentives. 

Curve Finance

Curve finance is the largest decentralized exchange in the Defi world. The value locked on the platform is over $7.5 billion. The liquidity pool helps the users to earn up to 30% APR. According to the official website, the fee on all pools is 0.04%, of which 50% goes to liquidity providers, and 50% to veCRV holders (members of the DAO).

How do yield farms generate returns?

Once a user has deposited the funds in the liquidity pool, the funds are then further used to lend out to borrowers for trading, arbitrage opportunities, etc 

What are the risks associated with yield farming?

1. One of the most common risks in yield farming is impermanent loss which is a temporary short-term loss of funds that arises due to volatility in the market. This mostly happens with decentralized exchanges (DEXes) where holders are required to deposit pairs of tokens
2. Yield farming is more prone to hacks and thefts as it is based on smart contracts. Though smart contracts are secured, they have this inseparable risk. Eg Harvest Finance hack and loss of funds. 
3. Bugs/malfunctioning in smart contracts is one of the most prominent risks in this high trading - volatile activity that a user needs to account for. 
4. A lot of times, meme tokens and coins are issued to the users portraying high returns. These tokens, in turn, don’t possess any tangible value. 
5. Yield farming and strategies that are used to generate returns are complex in nature and the returns are only visible on large capital amounts. 

How to get started with yield farming?

Pick a defi platform and demonstrate the steps of getting started

• In order to get started with yield farming, one has to first choose the Defi platform. In our case, we shall go ahead with Uniswap. 
• Once you log on to https://uniswap.org/, launch the app and connect your wallet. Next, choose the option of “pool” to engage in yield farming. 
• Click on “New Position” to get into the exchange. 
• Select the crypto asset you need to exchange. For eg. Eth with Dai. The platform would show the price range, per eth/dai price and the fee charged on the same. 
• Proceed to execute the transaction. Add the relevant amount to your wallet. Once the transaction is executed, you’ll see the updated coins in your wallet. 

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