How to start cryptocurrency yield farming

If you have spare cash you don’t need right away, you might put it in a savings account where it will earn you some interest while it’s not being used. It’s possible to do a similar thing with your cryptocurrency holdings, thanks to a process called yield farming. Yield farming lets you generate interest on the cryptocurrency coins and tokens you own with very little effort.

Yield farming is one of the most popular ways to generate a profit from cryptocurrency without having to actively trade it on a regular basis. In this AAG Academy guide, we’ll explain yield farming in more detail, look at the benefits and risks, and explain how you can get started.

What is cryptocurrency yield farming?

Yield farming, which is sometimes referred to as liquidity staking, is a way to generate interest on your cryptocurrency holdings. It’s ideal for those who own coins and tokens that they don’t want to sell or trade, but still want to generate a consistent profit on their investment. Yield farming can generate generous returns, but it does not come without its risks.

Yield farming typically requires cryptocurrency holders to stake or lend their coins and tokens for a period of time. During this period, the cryptocurrency is locked up and cannot be used by the holder, but in return for their contribution, they have the opportunity to earn interest or rewards on their coins and tokens — usually paid in the form of more cryptocurrency.

The hope is that when the holder gets back their cryptocurrency, they end up with considerably more than they originally started with. Assuming that those coins and tokens are worth around the same amount, or perhaps even more, the holder will have increased their wealth and they will be able to sell at a much higher price than they initially invested.

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How does DeFi yield farming work?

With decentralized finance (DeFi) yield farming, you may lend your cryptocurrency coins and tokens to other people — as if you were offering a loan. This is possible through a wide range of DeFi applications, including Aave, Compound, Curve Finance, and MakerDAO. The borrower then pays interest on that loan, so the lender gets back more in the long run.

You may also lend your cryptocurrency to be used by a decentralized exchange (DEX) to facilitate trading. In this scenario, rather than earning interest on the coins and tokens you have contributed, you are likely to receive a share of transaction fees every time a trade is carried out using the cryptocurrency you have provided.

In most cases, your cryptocurrency is combined with that of others in what’s called a liquidity pool. Interest rates can vary from a single- to three-digit percentage points, depending on how your cryptocurrency is used. DeFi lending is facilitated by smart contracts, so they are usually entirely automated and require no input from a middleman, unlike a traditional loan provider.

DeFi yield farming typically requires lenders to lock in their cryptocurrency for a certain period of time. During that window, the coins or tokens are not accessible, so they cannot be sold or traded.

What are the benefits of yield farming?

Yield farming is an increasingly popular way to make your cryptocurrency work for you while you own it. Rather than leaving it sitting in your wallet in the hope that its price will rise over time, or actively trading it in an effort to make a profit, you can instead use it to passively generate more cryptocurrency tokens with very little effort required.

Depending on the method of yield farming you choose, the interest rates and rewards can be very generous, so it is possible to increase your wealth quite considerably over a relatively short period of time.

What are the risks of yield farming?

Of course, no investment method is without its risks, and those that offer the best returns tend to be the riskiest. You shouldn’t be too surprised to learn, then, that yield farming isn’t an entirely foolproof way to generate more cryptocurrency. Here are some of the biggest and most common risks you should be aware of before you begin:

Composability risks
Whenever you trust someone else, such as a DeFi provider, with your money (or your cryptocurrency), you must accept that there are composability risks of some kind. Even major financial institutions can go bust, leaving customers struggling to get back their money. When you start yield farming, then, it is important that you understand similar risks are involved.

Although it may be unlikely, it’s not implausible that a blockchain could suffer an attack, that a bug in a smart contract’s code could cause catastrophic failures, or that other serious issues could occur. In any of these scenarios, cryptocurrency losses are a possibility.

Impermanent loss
Impermanent loss is perhaps the biggest concern in yield farming since it is so common. This is when the tokens you’ve contributed to a liquidity pool change in value compared to how much they were worth when you first deposited them. The more significant the change, the more you could lose when it’s time to withdraw your stake.

For instance, let’s say you lend $1,000 worth of Bitcoin, and while your coins are locked up and unable to be sold, the value drops to just $600. You’re now down $400 when you get those coins back, so if you sell at this point, you suffer a considerable loss.

Rug pulls
We have another AAG Academy guide that looks at rug pulls in-depth, so we won’t go into too much detail here, but in a nutshell, a rug pull is what happens when a project’s creators take all the funds from a liquidity pool and leave investors with nothing but a pile of tokens that are now worthless. When this happens, anything you’ve contributed to the project is lost.

Examples of yield farming platforms and protocols

In addition to the platforms mentioned above, other popular yield farming options include:

• DeFi Swap
• eToro
• PancakeSwap
• Uniswap
• Venus

How to calculate yield farming returns

It can be difficult to calculate yield farming returns if you are trying to do it manually. Fortunately, there are a wide range of great (and free) yield farming calculators available. These can not only help you work out potential returns on your passive investments, but they can also help you prepare for how much you may lose due to things like impermanent loss.

Here are some great yield farming calculators you might want to try:

• Alpaca Yield Farming Calculator
• CoinGecko Impermanent Loss and APY Calculator
• DeFi Yield Advanced Impermanent Loss Calculator

References

• Defi yield farming
• Defi apps