Do you have some cryptocurrencies in your wallet?
Well, why not park them in decentralized finance (DeFi) protocols and earn returns on them that would otherwise be sitting idle generating no returns.
Yes, this is called DeFi yield farming.
You can think of it as depositing money in a high interest-bearing account.
The only difference is unlike traditional savings accounts, yield farming ecosystem is decentralized and offers skyrocketing returns. You can earn an annual percentage yield (APY) of over 100% in yield farming.
Read on to learn yield farming in detail. We will discuss everything from what is DeFi yield farming, top yield farming projects to a step-by-step guide to getting started with yield farming.
Let’s dive in!
What is DeFi Yield Farming?
Yield Farming is a way to earn passive income on your cryptocurrency holdings by depositing them in decentralized finance (DeFi) protocols.
Don’t confuse yield farming with staking. In most cases, yield farmers are required to add funds to liquidity pools to facilitate transactions and in return, you get fees based on your contribution to the liquidity pool.
What is a liquidity pool, you ask?
Liquidity pools are smart contracts that store user funds to facilitate trade (exchange, borrowing, lending) in a decentralized setting. Liquidity providers (LPs) deposit funds in these pools and earn rewards in return.
Most commonly, yield farming is carried out using Ethereum-based tokens – ERC-20 and Binance Smart Chain-based tokens – BEP-20.
How Does DeFi Yield Farming Work?
In yield farming, you need to deposit funds in liquidity pool smart contracts and that’s it. You will start earning reward tokens for supplying liquidity.
You can further reinvest these reward tokens in other liquidity pools and earn rewards. Thanks to this, yield farming strategy can be quite complex to figure out.
Your yield farming returns are dependent on the yield farming protocol’s rules and the amount you invest in it. Moreover, you can move your funds into the highest-yielding DeFi protocols to maximize your returns. However, this requires good know-how of the yield farming space.
How To Get Started With DeFi Yield Farming
1. Know The Pros And Cons Of Yield Farming
As discussed, yield farming strategies can be complex. To understand yield farming better, let’s learn about its pros and cons.
Up to 100% APY
Normally, in staking protocols, you would get 8-10% APY on stablecoins such as USDT, USDC, and DAI. However, DeFi yield farming can give you as much as 100% APY (annual percentage yield) on your crypto holdings.
No barrier to entry
All you need to become a DeFi yield farmer is Ethereum, Binance Coin (BNB) in some cases, and a crypto wallet, that’s it.
There are plenty of Farming-Centric dApps
The decentralized finance space is teeming with yield farming applications. If you have invested in a variety of DeFi protocols, you will be overwhelmed while tracking your portfolio.
Don’t worry, there are a variety of dApps that help yield farmers to keep a close tab on their investments and annual percentage yield from a simple and all-in-one interface.
High Gas Fees On Ethereum
For those who don’t know, gas fees are the amount you pay for transactions on the Ethereum blockchain. Due to high traffic on the Ethereum network, gas fees have been skyrocketing lately.
Since many yield farming smart contracts are based on Ethereum, you need to pay gas fees while you make transactions.
In short, be alert while you calculate your yield farming returns. Sometimes, the gas fees could be much higher than your expected reward.
Nonetheless, with the Ethereum 2.0 upgrade, gas fees could become significantly less. Till then, watch out for gas fees before calculating farming returns.
The crypto market is volatile and unstable. As a result, there’s a risk of inconsistent returns in the Defi yield farming space.
Moreover, as it is easy for anyone to become a yield farmer and earn benefits, profitable yield farming strategies are tough to figure out.
Risk Of Impermanent Loss
Impermanent loss occurs when the price of your crypto deposits diverges drastically compared to when you deposited them in liquidity pools.
Technically, in an Automated Market Maker (AMM), funds are added in a pair. Due to the drastic divergence, the pair is imbalanced causing the value of your deposits to dwindle.
2. Understand What Is TVL
Total value locked or TVL is the amount of crypto tokens that are currently staked in a specific liquidity pool.
TVL is an important metric to check the health of a DeFi yield farming protocol. The math is simple, the higher the total value locked, the more people are trusting the platform, the more its yields.
Remember, as the total value locked in a yield farming protocol increases, your farming returns will also rise.
3. Select A DeFi Yield Farming Platform
In this section, we will discuss how to start yield farming on two of the most popular DeFi yield farming protocols – Compound and Uniswap.
Before we dive into these protocols, let’s look at what all you need in order to begin yield farming.
How To Participate In DeFi Yield Farming
- Buy cryptocurrencies that are used on the particular yield farming protocol. The most widely used cryptocurrencies include ETH, BTC, and stablecoins such as USDT, USDC, DAI, BUSD (for farming on Binance Smart Chain).
- Download a decentralized wallet. The most popular wallets are Metamask, Trustwallet, and Wallet Connect. While installing, make sure the private keys and seed phrase are secured and kept safe for backup.
- Once you have downloaded your preferred wallet, transfer your crypto holdings to the wallet.
- Head over to the dApp section of your wallet and start farming.
Yield Farming On Uniswap
Uniswap has the largest liquidity pools in the DeFi space. It is amongst the most well-known Automated Market Maker (AMM) protocols on Ethereum.
At Uniswap, you become a Liquidity Provider (LP) by adding funds in Uniswap liquidity pools to earn LP rewards. Every time a trade is executed on the liquidity pool you contributed funds to, you will earn a fee for facilitating that transaction.
As of now, Uniswap has a trading fee of 0.30% per token swap. These fees are distributed to LPs for providing liquidity.
To become a liquidity provider on Uniswap, you need to deposit the equivalent value of each token in a liquidity pool.
Say, you wish to add funds to ETH-DAI liquidity pool. Here, if you choose to add 1 ETH you need to add 2,675 DAI ( as of current exchange rates) to balance the 50-50 pool ratio.
How To Farm On Uniswap?
- Visit Uniswap.org.
- Select the ‘Launch App’ tab.
- Click ‘Pool.’
- Connect your wallet by clicking on ‘Connect Wallet.’
- After you are connected to Uniswap, you need to choose a liquidity pool. For this, you can either browse popular liquidity pools by clicking on ‘Top Pools,’ or select ‘New Position.’
- Say, you clicked on ‘New Position.’ Now, you can select your preferred token pair.
- Review your Fee Tier. On Uniswap v.3, there are three different Fee Tiers – 0.05%, 0.3%, and 1.0%. The 0.05% fee tier is best for assets that trade at a fixed or highly correlated rate such as stablecoins. The 0.3% fee tier gives better returns on pairs that undergo price fluctuations, such as the ETH-DAI pair. The 1.0% fee tier is to bet on exotic pairs with greater risks. In short, the higher the risks, the higher you set your fee tier.
- Set a specific price range in which you can provide liquidity.
- Now, deposit the desired token amounts.
- Select Add > Preview and Approve Transaction on your wallet.
Yield Farming On Compound
Compound is an Ethereum-based credit platform that allows users to lend and borrow crypto assets.
As a lender, you will offer a loan by depositing funds in the liquidity pool and in return receive interest on the loan provided. The interest is calculated based on the supply and demand of the crypto assets you provide.
Lending cryptocurrencies on Compound is one of the easiest ways to earn yields. Deposit stablecoins such as DAI or USDC and you will start earning yields instantly.
Nonetheless, the major attraction on Compound is their native governance token COMP and their interest-bearing tokens called cTokens.
Here’s how they work
If you lend or borrow on Compound you get COMP tokens. Currently, 2,312 COMP tokens are distributed every day on Compound.
Once you do the math, you realize that it results in nearly $400 per governance token. This is a whopping $920,000 in additional rewards each day.
These rewards are given to lenders and borrowers on the Compound platform. Thanks to this, despite the relatively low APY on Compound, the yield farming returns remain significantly high.
Compound’s native interest-bearing tokens, cTokens are paid to yield farmers for providing liquidity on Compound.
For instance, if you deposited 5 ETH, you will get 5cETH tokens representing your funds. These tokens earn you interest plus you can redeploy these cTokens on other DeFi platforms as well.
How To Farm On Compound?
- Go to Compound.Finance.
- On the top right corner click on ‘App.’
- Connect your wallet.
- Enter your password and approve the connection.
- Now, select the crypto token you wish to deposit to start farming COMP.
- In case, you wish to deposit stablecoins such as DAI, for instance, you need to first click ‘Collateral’ and then ‘Use DAI As Collateral.’
- Then you will need to confirm your DAI collateralization and pay a small ETH transaction fee. After your transaction is complete, you can deposit DAI on Compound and start farming COMP.
- To check your APY go to the ‘Dashboard section.’ There you will see your ‘Supply Balance’ and ‘Interest earned and paid, plus COMP.’
Yield farming is amongst the best ways to earn passive income on your crypto holdings. All you need to do is park your crypto assets in high-yielding DeFi platforms and start farming liquidity rewards.
As mentioned, DeFi yield farming can get you over 100% APY on your cryptocurrencies. This is why many cryptocurrency investors are entering the yield farming market.
If you are a beginner, Compound is the best fit for you. As you gain experience in yield farming you follow advanced yield farming strategies and move your funds in several yield farming protocols to get massive returns.
Also, remember, DeFi yield farming is indeed enticing, thanks to the sweet profits. However, you should only become a yield farmer after understanding all the risks involved in it.
Anish loves reading, researching, and writing about crypto and blockchain. He started his crypto journey early in 2017, what started as a fad is now a full-time hobby. He curates guides after thorough research on platforms and is responsible for the most in-depth guides on the site. You will find him walking his dog (not Doge) when he is from his Laptop.