What is yield farming?

What is yield farming?

Yield farming is a set of specific investment strategies with the major idea of generating passive income by lending owned crypto-assets and using various pools and smart contracts. Just like in traditional farming, to get a crop, you have to give something away first. This main principle can also be seen in crypto yield farming, considered below.

As soon as your funds are locked in the smart contract of the particular pool, you will start receiving the desired reward. In other words, the user who stakes his own cryptocurrency assets in the pool ends up becoming a provider.

The traders need liquidity for their own transactions, so they can use a pool but have to pay a fixed fee for each transaction to all liquidity providers of the pool they are using. These fees are distributed among liquidity providers in accordance with their share in the particular pool.

Extra rewards can also be obtained by specific tokens. It all relies on the type of liquidity pool. Furthermore, some investors are passionate about governance tokens, which can be earned by yield farming. Such tokens provide voting power to a holder within a protocol they represent. Governance tokens can be staked further to get extra yield.

The Defi Watch shows users essential metrics like Rewards, Fee, APR, TVL, ROI

The Defi Watch shows users essential metrics like Rewards, Fee, APR, TVL, ROI.

The yield depends not only on the amount contributed to the pool but also on the specific distribution rules for reward. Consequently, the investor can keep the earned tokens and exchange them or invest them in other profitable pools.

There are also cases when rewards are autocompounded with an initial investment, thus generating a long-term extra yield. And so on to the moon.

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The farmers' profitability in the pool can be judged by an annual percentage rate indicator, aka APR. This means a yield that a farmer can get in a year if all the values remain stable. The DeFi Watch dashboard contains the Total APR for each liquidity pool. APR figure does not include manual compounding effects.

However, it's not that simple. Everything in the marketplace is subject to change. The rewards and the conditions of their distribution may also be unstable. The competition and risks in the DeFi world are high. Even more, some of the effective investment strategies will never be revealed because they would immediately lose their yield.

So good investors consider the risks and regularly move their assets between different pools in search of higher returns from cryptocurrency lending.

Catherine Woods
Catherine Woods

Crypto journalist