The model in which people who own digital assets lend their assets to other users to earn income is called Yield Farming. The Yield Farming model helps investors provide liquidity to the cryptocurrency system. The main reason why Yield Farming has become so widespread is the rise of decentralized finance(DeFi) projects. It may change the way investors
HODL
in the future. It offers a system where investors can earn by operating their assets rather than holding their crypto coins in the long term.
The working principle of Aave (LEND), Compound (COMP) and Maker (MKR) protocols, which are among the recently mentioned DeFi projects, is based on the Yield Farming model.
The Relationship Between DeFi and Yield Farming
While the fame of cryptocurrencies continues to increase day by day, one of the stars of 2020 can be called DeFi, which uses the Ethereum network. Yield Farming is seen as one of the shining stars with DeFi projects. Yield Farming, which will be mentioned a lot in the future, is already among the terms that are researched and tried to be learned in the crypto money sector.
Due to the rapid increase in the variety of decentralized finance projects, different ways of earning have also begun to form. Many DeFi projects are also built on the Yield Farming model. It is a model created to make money from cryptocurrency mining as well as DeFi applications built on Ethereum. At the beginning of December 2020, the total amount locked into DeFi protocols managed to leave behind $ 14.40 billion.
How Does Yield Farming Work?
The user who has crypto money in the lending system adds the crypto coins to the pool of the service provider. With this money, interest is earned at a determined rate when not traded for a certain period of time. Crypto coins added to the pool are considered locked after they are added and there is no possibility to access these coins for a certain period of time.
In the Yield Farming model, which is different from the term deposit accounts in the classical banking system, tokens are given as a reward by the system in exchange for locked coins. Investing, user; It can use the asset locked in the system to earn income for different purposes in a way that the interest will not change during the maturity period.
The important risk factor here is that if the invested coin experiences a decline, unfortunately there is no chance to intervene.
To explain this with an example from Maker (MKR);
If the investor locks 1000 ETH in his possession on the Maker network, he will be given 1000 mETH in return. At the end of the term, 1000 mETH is converted back into 1000 ETH. In addition, interest income is obtained. If ETH appreciates against the dollar during the maturity period, it gains due to the exchange rate difference as well as interest.
What are the Differences with the Staking Method?
The Yield Farming model is different from the “Staking” model, which allows earning income by simply locking crypto money into the network. In the staking model, participants in the network profit by promising to keep their crypto coins in their wallets within a certain period of time.
As in Staking, Yield Farming does not make a profit by keeping investors in pools in any exchange or wallet. In order to do Yield Farming, it is necessary to deposit the coins in DeFi pools and buy them from the pool’s token.
Yield Farming Platforms and Leveraged Trading
Since DeFi money markets are not governed by anyone, over-collateralization is used to ensure that people who do not know each other at all can borrow safely. In order to make more money using DeFi protocols, users have to invest more in the system than they want to borrow.
Yield Farming is the choice of financial speculators who trade with leverage rather than those who are stuck in emergency money.
Investors engaged in Yield Farming usually use the platforms listed below.
- Uniswap
- Compound Finance
- Maker DAO
- Synthetix
- Aave
- SushiSwap
- Curve Finance
- Balancer
- Yearn. Finance
Among the Yield Farming pools that get the most attention are Curve, Uniswap, Synthetix, and Balancer.
Liquidity providers earn commission income on the assets they invest in these pools. Each pool has its own calculation method and income model. For example, the Uniswap pool offers 50 percent structuring between two assets, while the Balancer allows up to 8 assets.
Undoubtedly, DeFi money markets can help create a financial system that is more open and accessible to anyone with an internet connection.
Yield Farming Risks
Yield Farming is not as easy as it seems. The most profitable Yield Farming strategies are quite complex. Recommended for advanced users only. In addition, this system is usually more suitable for investors (i.e. whales) who have a lot of capital. One of the obvious risks of the system is smart contracts. Due to the nature of DeFi, many protocols are created and developed by small teams with limited budgets. This can increase the risk of smart contract errors. If Yield Farming is to be used, it can be examined through previously proven DeFi projects.
DeFi protocols are decentralized and can integrate seamlessly with each other. If only one of the blocks does not work as intended, or if DeFi projects are not adequately secured, they can be attacked by malicious actors and the entire ecosystem can be damaged. This is one of the biggest risks for investors and liquidity pools.
