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As the rise in the new financial protocols continues, there is a rapid increase in the number of users. Decentralized finance (Defi) has shown significant progress in the blockchain space. The fact that they are permissionless and trustless makes them unique.
One of the new concepts that have emerged recently is Yield farming. It is more commonly referred to as the process of earning the native platform tokens using the protocol.
In this article, we will provide the complete guide of Yield farming and its overall aspects. Let us look into this Yield farming review in detail now.
As COMP token, the native token of Compound finance was launched, it formed a key part in the Defi ecosystem. Thus this led to the development and launch of Yield farming. Yield farming paves the way for earning interest through your holdings.
Weeb McGee was the person who built Yield farming. It is considered to be one of the most popular tools in decentralized finance. Since then, many other Defi projects have shown up. They aim to attract liquidity in their ecosystems.
Yield farming has shown extensive growth and since its launch and continues to show rapid progress in the Defi ecosystem.
What Is Yield Farming?
Yield farming provides a means of earning interest by investing crypto in the Defi market. Through the concept of smart contracts, it helps you to lend your funds to other users. With this, you will earn some fees in the cryptos.
Yield farming paves the way for earning rewards with your cryptocurrency holdings. In general terms, you get rewards in return for locking up the cryptocurrencies. Yield farming is often also referred to as liquidity mining.
Yield farming works by using the ERC-20 tokens on Ethereum. The rewards earned are also typically a type of ERC-20 token
How Does Yield Farming Work?
Yield farming relates to a model called automated market maker (AMM). It usually involves liquidity providers (LPs) and liquidity pools. The funds are being deposited into a liquidity pool by the liquidity providers.
These funds in the liquidity pool provide a marketplace to exchange, lend, or borrow the tokens for the users. When you use this system you will incur some fees. According to the share of their liquidity pool, they are paid out to the liquidity providers.
In addition, another incentive to add funds to a liquidity pool would be the distribution of a new token. The bottom line is that liquidity providers get a return based on the amount of liquidity they are providing to the pool.
Stablecoins are usually the funds deposited which are pegged to the USD. Some of the most common stablecoins used in Defi are DAI, USDT, USDC, BUSD, and others. Some protocols will mint tokens that represent your deposited coins in the system.
For example, if you deposit DAI into Compound, you will get cDAI or Compound DAI. If you deposit ETH to Compound, you will get the cETH.
What Kind of Coins Are Involved?
There are a wide number of coins involved in yield farming. The compound is the largest one which currently has nearly $550 million in funds. Other major coins involved include Balancer, Synthetix, Curve, and Ren. Today, these services hold more than $1 billion in locked user funds, which are funds that are used in lending.
Supposedly, the holders of coins like Comp can participate in the governance and improvement of these networks. But the vast majority of people using them currently are speculators, trying to earn quite little returns.
Why Is Yield Farming So Hot Right Now?
All the cryptocurrencies have seen a rise in the interest due to the high volatility in many of the traditional assets. This also resulted in the rise of yield farming.
In addition to this, they offer rewards which include some of the highly attractive tokens. They also possess some of the high-profile backers like Andreessen Horowitz and Polychain.
There are no minimum capital requirements that are needed in any of these opportunities. Thus significant returns are largely earned with capital contributions starting from about $1000 in value.
The Risks of Yield Farming
The highest-earning yield farming strategies are suggested only for advanced users and are highly complex. Also, yield farming particularly applies to those users who have a lot of capital.
Smart contracts are one of the major risks of yield farming. Many of the protocols are being made by small teams with limited budgets owing to the feature of Defi. This significantly increases the risk of the smart contract bugs
Due to the immutable and peculiar nature of the blockchain, this can lead to the loss of many of the user funds. Hence while locking your funds in a smart contract, you have to take care of this feature.
What Is the Future of Yield Farming?
As the sector gets more advanced, the developers will show up with more rapid ways to optimize the liquidity incentives in many efficient ways. It could turn up that the token holders are implementing more ways for the investors to earn profit from the Defi niches.
There is no doubt that yield farming would bring a revolution in the decentralized finance platform in the coming future. However, the liquidity protocols and the other Defi products form the base of crypto-economics, computer science, and finance.
With any Defi product, there is always a very small chance of loss meaning no user should add more capital than they would be willing to use. Yield Farming basically works on decentralized liquidity protocols. There are certain rules which abide by the platform.
The most common way is by lending digital coins such as Tether or DAI. It is made through a Dapp such as Compound, which lends the coin further to the borrowers. The interest rates depend on demand. But as you participate in the compound service, you will earn COMP coins, other fees along with the interest.