What is Yield Farming?
In agriculture, for farmers (Farmer), “Yield” means crop yield, which is a measure of the total amount of agricultural products they harvest.
Here, “Farmer” is the user, “Yield” is the interest they earn based on the original assets they deposit.
Yield Farming is a term that refers to those who generate as much return as possible from their invested assets by providing liquidity to investors. DeFi protocol (Decentralized Finance – Decentralized Finance).
How does Yield Farming work?
Yield Farming is closely related to the automatic market making model – AMM (Automated Market Maker). Popular AMM models can be mentioned as Uniswap, Mooniswap, Balancer…
In Yield Farming, Liquidity Providers (abbreviated: LPs) provide liquidity to the protocol’s Liquidity Pools. Liquidity pool simply means Smart Contract that contains money in it. These pools allow users to borrow, lend or exchange tokens between tokens.
The revenue generated by Liquidity Pool is the transaction fee when the end user performs activities in the Pool, such as borrowing, lending, exchanging Tokens. This revenue will be divided back to the LP according to the percentage of liquidity they have provided in the Pool.
In addition to fee revenue, some protocols implement Bootstrapping Liquidity for Protocols by distributing native Tokens to LPs that have provided liquidity into their protocol (maybe across the protocol pool or several pools). Nominated). This is called Liquidity Mining.
Liquidity Mining can be understood as a narrower concept than Yield Farming. Specifically, LPs will in addition to receiving money when providing liquidity, they will receive another new amount of Tokens.
Outstanding Yield Farming Platforms
Some popular Yield farming platforms in DeFi:
- MakerDAO: Use Maker mint for DAI, use DAI for Yield Farming in other protocols like Compound.
- Compound: Provide liquidity to Compound to farm COMP and earn profit from borrowing and lending.
- Uniswap: Provide liquidity to the Pool to collect transaction fees.
- Balancer: Farm BAL and other Governance Tokens support Pool on Balancer.
- Synthetix: Use SNX mint sUSD, bring sUSD to provide liquidity in pools on other platforms.
- Aavee: Borrowing and lending money, fast loans (Flash Loan). From there providing liquidity in other platforms, Farm more.
- Curve Finance: Provides liquidity and collects fees, interest and CRV.
- yEarn Finance: Provide liquidity and collect fees, Farm YFI.
Influence of Yield Farming
Yield Farming’s influence in DeFi is undeniable. DeFi has developed extremely fast after Compound launched Liquidity Mining with COMP Governance Token. This event then led to other projects launching similar programs to attract liquidity to the protocol, causing DeFi to heat up like never before.
Liquidity is poured from one protocol to another. High profits plus a strong increase in the administrative token made the capital inefficient (Unproductive Capital). Start moving into Defi protocols to do Farming and make profits, become productive capital (Productive Capital).
Money is pouring into DeFi, so DeFi projects are constantly appearing with new distribution methods, taking advantage of available protocols. Typical among them can be mentioned Yam Finance.
Result: Total Value Locked (TVL) in the DeFi ecosystem has increased more than 7 times, from 1 billion to 7 billion dollars within 3 months.
For those of you who do not understand Total Locked Value (TVL): TVL is an indicator used to measure the “health” of Yield Farming and DeFi platforms. TVL measures the amount of Crypto assets locked in DeFi protocols such as lending protocols and others.
In addition, the Governance Tokens and related DeFi projects have increased very strongly.
Looking at the chart above, we can see that the price of COMP reached its all-time high (ATH) in June, thanks to COMP Farming which caused a huge increase in COMP demand.
Risks of Yield Farming
Most of the Yield Farming strategies that bring APR/APY (Annual Percentage Rate/Annual Percentage Yield) are mostly very complicated and require the user to know very well the what they are doing. If you don’t really understand how real exchanges work, the possibility of losing money is very high.
Some risks of Yield Farming:
- Smart Contract Risk: Most protocols are developed by small teams, with little capital, so there is an increased possibility of bugs in Smart Contracts (because there is no budget to audit). Audited Protocols are still capable of bugs and stolen money as in the case of Bzrx, Curve…
- System Design Risks: In some protocols like Uniswap, the provision of liquidity can cause LPs to experience rare losses (Impermanent Loss) when the price of an asset in the Pool fluctuates very quickly… or LPs may be completely withdrawn when providing liquidity as was the case with Balancer.
- Risk of Liquidation: Collateral can be subject to extreme volatility and users’ positions to be liquidated during extreme market volatility.
- Bubble Risk: Since COMP launched Liquidity Mining, the whole DeFi community started FOMO a lot, leading to the risk of bubbles appearing in DeFi.
Yield Farming – Game of the Whales
The winners in this game are the Whales – those who take tens of millions of dollars to Farming, thereby earning the Admin Token. Whales simply has a relationship with the project, spending large Farm money making the odds of the odd players smaller.
Early FOMO retail investors can make a lot or lose their invested money. Those who lose money will be the ones who FOMO in later, when the price has gone too high.
So to reduce risk, we should be early farmers and buy some Governance Tokens at an acceptable price, which is considered a lottery.
Some thoughts on Yield Farming
Firstly, Yield Farming has ushered in a new era for DeFi with its Bootstrapping protocol method through Liquidity Mining. This can be said to be a good way to attract users in the short term.
Second, when the protocol launches Yield Farming can affect other protocols, to go up together. But, this interaction won’t last as Yield decreases. Typically yEarn, Bootstrapping for yEarn and Curve and Balancer.
Both point 1 and point 2 are short term.
According to Jesse Walden (former Associate of a16z), DeFi protocols that want to go long-term will need to rely on users and creators: “Profit hacking in DeFi is a short-term driver of growth. user. But the bigger game is to create long-term wealth by building (and owning!) a piece of products and services that billions of people will use every day.”
See more: Long-term Crypto Investment for Newbies
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