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Comprehensive Guide on DeFi Yield Farming to Unlock its benefits

DeFi Yield farming is at the cutting edge of crypto-economics, offering yield farmers the opportunity to reap rich rewards. These dynamic yield farming platforms can bring in better returns for those staking or lending cryptos assets in the form of tokens that in turn can be used to access certain products and services. Prolitus can help develop a DeFi yield farming platform with features and add-ons that works best for your business!

Crypto investors can now access multiple avenues to make riches thanks to the emergence of the decentralized finance (DeFi) concept. Being the pioneer of financial and crypto-economics innovation, DeFi allows for novel ways for people to earn passive income with their crypto holdings using the decentralized ecosystem. An emerging hot trend in the DeFi space is Yield farming. Let’s understand how it works, the benefits that make it a ground-breaking concept in the DeFi space, and also understand how businesses can reap rich gains from the launch of a yield farming platform.

Overview of DeFi Yield Farming Development

Yield farming is a brilliant investment strategy of DeFi that empowers people to make cryptos from more cryptos. With automated smart contracts, you can lend your funds to others and in return get your fees in the form of cryptos. It may sound simple but in reality there are complicated strategies used by yield farmers to move funds around all the time between different lending marketplaces to make optimum gains from it. Let’s dive deeper into the DeFi yield farming world and understand how it works, what kind of yields can farmers expect, how to start yield farming, and also the different complexities involved with this concept.

Introduction to the revolutionary craze of DeFi sector – Yield farming

Crypto holders can now earn rewards with the help of yield mining and this is why this new strategy of Defi is also popularly called as liquidity mining. Crypto holders can lock up cryptocurrencies and get rewarded and it is also for this reason that there are parallels drawn to it with the concept of staking.  Liquidity providers put in their tokens to the liquidity pools. In lieu of providing liquidity to the pool, they are provided with rewards. The rewards are generated as fees by the underlying DeFi platforms or may be given out to liquidity providers as multiple tokens. Those reward tokens are then deposited to other pools to earn rewards and so on. 

ERC-20 tokens are used for yield farming and the rewards are also given out on these tokens.  Hence much of the yield farming activity is being done on the Ethereum ecosystem but this might change in the future. DeFi applications may be allowed to run on other blockchains that back smart contract capabilities.

In the case of yield farming, farmers will generally move their funds and cryptos among different protocols and through different marketplaces with a view to getting better yields. Another key element of this Defi concept is how yield farmers are highly secretive about their strategies as it is believed to become less effective when more people come to know about it. As per reports, the market cap of yield farming was estimated to be around $10 billion in 2020, up from $500 million, thereby significantly driving the growth for the DeFi sector.

The way in which DeFi yield farming works

It is important for the functioning of the DeFi platforms to have cryptocurrencies and users also called as liquidity providers (LPs) provide their cryptos to support the DeFi platforms. Liquidity pools with smart contract capabilities wherein all funds are stored are facilitated with tokens or even coins by users. The liquidity providers lock up their coins or tokens into the liquidity pool and in lieu of this they are rewarded with a fee or an interest that is generated from the underlying DeFi platform on which the liquidity pool runs.

In simple terms, yield farming facilitates a fabulous income opportunity for yield farmers through the lending process of their tokens with the help of a decentralized application (dApp). The token lending takes place through smart contracts with no middlemen or intermediaries in between, thus removing the need for third-party members.

The DeFi marketplaces are empowered by the liquidity pool as it allows crypto holders to borrow or lend tokens. Users are required to pay fees for using these marketplaces and this fee in turn is further used to pay the liquidity providers for lending or staking their coins or tokens in the liquidity pool. Most of the yield farming activity is run on the most popular blockchain platform – Ethereum and this is the reason for which the rewards provided are a type of ERC-20 token.

Although it is entirely upon the wish of the lenders and yield farmers to use the tokens in the way they desire, most of them are largely speculators on the constant lookout for arbitrage possibilities by benefitting from the token’s volatility in the marketplaces.

Yield farming unique propositions

Yield farming came at the forefront of the DeFi space with the launch of governance tokens of the Compound Finance ecosystem also called the COMP tokens. These tokens let the crypto holders be a part in the governance of a DeFi protocol by granting them governance rights. 

DeFi Yield Farming

The distribution of the governance tokens is based on algorithms with liquidity incentives and makes the network as decentralized as needed. It provides incentives to potential yield farmers to allow them to farm the new tokens and give liquidity to the protocol. The launch of the COMP pushed up the popularity of the yield farming token distribution method.  It is since the acceptance of this token distribution method that other DeFi projects too have brought forth advanced schemes to attract liquidity to their ecosystems.

Yield farming platforms and protocols

The success of any DeFi project largely depends on the yield farming protocols and platforms used for the project. For investors looking to tap in the greater benefits of the DeFi yield farming concept, it is imperative to be acquainted with the popular yield farming protocols in practice. Awareness about the features of the entire existing yield farming protocols can help investors make an informed decision with regard to their fund allocation that brings on greater returns. The popular yield farming protocols operating on the DeFi platforms and making huge impact on the ecosystem include the following:

Compound Finance – For yield framers looking to jump on this exciting DeFi space should explore the core protocol of the entire ecosystem – Compound Finance. Users in this yield farming platform are allowed to lend and borrow assets. Liquidity providers with an Ethereum wallet can add funds to the pool and get rewards that instantly initiate compounding. It is on the basis of supply and demand on which the rates are adjusted algorithmically.

MakerDAO – The decentralized nature of this credit platform backs the formation of DAI, a stablecoin algorithmically attached to the value of USD. Yield farmers can lock their collateral assets such as BAT, USDC, or WBTC on a Maker Vault. They can also use this core protocol to mint DAU and use it in yield farming strategies. DAI can be generated as a debt against the locked collateral. This debt accumulates interest over time in the form of a stability fee and the rate is set by the token holders.   

Synthetix – Yield farmers can invest in the Synthetix Network Token (SNX) or ETH as collateral and can get their hands on the synthetic assets against it. Synthetic assets can be anything with a consistent price feed. Users could attach any type of financial asset to the Synthetix platform for yield farming.

Aave – Yield farmers can explore this specific decentralized protocol and either lend or borrow. Lenders can also give their tokens in lieu of their funds. The existing market conditions determine the interest rates. The tokens generate interest, which begins compounding immediately after depositing. Advanced functionalities such as flash loans are also allowed by Aave.

Uniswap – This decentralized exchange (DEX) protocol facilitates the way forward for trustless token exchanges. This is one of the major platforms for token swaps largely due to its frictionless nature and turns beneficial to yield farmers for giving them room for coming up with yield farming strategies.

Curve Finance – With the use of this decentralized exchange protocol, yield framers can efficiently swap their stablecoins. In contrast to other protocols, it allows users to exchange high-value stablecoin swaps with low slippage. 

Balancer – It is much like other liquidity protocols such as UniSwap and Curve but the major differentiating feature it possesses is that it lets custom token allocations in a liquidity pool. Liquidity providers are allowed to create custom pools and liquidity providers get fees for the trades taking place in their liquidity pool.  The flexibility it allows makes it one of the significant protocols for yield farming.

Yearn.finance – This ecosystem with a decentralized nature serves as an aggregator for lending services such as Compound, Aave, and others. It finds the most profitable lending services to optimize token lending. It works best for yield farmers on the lookout for a protocol that inevitably chooses the premium strategies for them.

How are yield farming returns calculated?

The projected yield farming returns are calculated in terms of the annual percentage yield (APY) or the Annual Percentage Rate (APR), which is an annual rate of return gained by the user over a year. It also includes the compound interest when calculating the APY. The key differentiator between APR and APY is that the former does not factor in the compounding effect while the APY takes into account even that. Profits are reinvested to earn more returns. 

However, these are simply projections and estimations. Often it gets difficult to assess the short-term rewards. The highly competitive and rapidly evolving market of yield farming witnesses the rewards to fluctuate significantly.     

The highly competitive and rapidly evolving market of yield farming also facilitates rewards that are subjected to extreme volatility. If a yield farming strategy generates good returns then it presents a great opportunity for farmers to jump on the lucrative possibilities thrown open by this new DeFi innovation. However, DeFi has to keep working out its metrics to calculate the returns from yield farming. Given the fast-evolving nature of the DeFi space, it is better to make weekly or daily estimated returns. 

What are the risks of yield farming?

Although the DeFi yield farming concept throws open lucrative earning opportunities, it is not free of risks. The complexity of yield farming makes it difficult for farmers to execute the right strategies and thus only advanced users are suggested to use them. Hence, it is recommended for use only by those with lots of spare capital to deploy.

There are also concerns of cyber theft, fraudulent activities, and regulatory risks looming large over the use of cryptocurrencies. As most digital assets are subjected to cyber security breaches and there is the absence of any concrete policies regarding cryptos, the deployment of DeFi yield farming also makes it one of the riskier matters.

The transactions cater to the digital assets using the software for storage purposes. Hackers are aware of the vulnerabilities and can exploit the codes to steal funds and use the data in the wrong way.

Besides, there is the risk pertaining to the unpredictability of tokens. The prices of cryptocurrency are subject to a lot of fluctuations and it is this volatility that makes yield farming quite precarious. Even the shortest bursts of volatility can impact the price of tokens, either pushing it up or crashing it down when it is locked up in a liquidity pool.  Thus, yield farmers can end up having unaccounted gains or losses. Hence a lot of farmers may feel better off by keeping their coins only available for trading.    

Another risk with yield farming is the presence of smart contracts in DeFi platforms. Although smart contracts facilitate smooth transactions, they are not unfailing. It is largely for the benefits and features of the smart contracts that one can witness a number of protocols being built and developed by smaller teams too. However, these small teams often face budget constraints and this can escalate the risk of bugs in the platform. However, this is just not the case with smaller teams but even in the case of bigger protocols, bugs and vulnerabilities are often discovered all the time. It can cause users to lose funds and hence the smart contract bugs are an important risk consideration to be factored in when locking funds in the pool.      

Moreover, the biggest strength of DeFi can also turn out to be its greatest risk. The permissionless DeFi protocols allow it to seamlessly integrate with each other, thus indicating that the whole of the DeFi ecosystem is heavily dependent on each of its building blocks. Hence the risk arises because of this very feature of Defi protocols as when one of the building blocks does not work as intended then the entire ecosystem too might have to suffer the consequences. Therefore, it gets risky for yield farmers to put their funds into the liquidity pool. They do not just need to put their trust into the protocol wherein they lock their funds but also depend on all the others it may rely on.  

Wrapping up

The financial revolutionary concept of yield farming involving the staking, or locking up of cryptocurrencies in exchange for interest or more crypto is certainly at the cutting-edge of crypto-economics and finance space. Although it is still a relatively new craze, it is likely to be mainstream with the increasing popularity of cryptos.      

There are great returns associated with yield farming but at the same time, there are also risks involved with it. Many things can impact your returns as there are possibilities of a surge or crash when your cryptocurrencies are locked up in the liquidity pool. Crypto markets are known to experience rapid price swings and thus there are risks posed on the returns in yield farming. Hence, it is best to understand how DeFi yield farming works and all the underlying risks associated with it too before jumping on to the opportunities before participating in the yield farms.  

Prolitus DeFi Yield Farming Platform Development Services

Explore the lucrative earning opportunities offered by DeFi yield farming and build your own platform with the help of a professional and experienced team. We at Prolitus can help businesses to tap into the endless possibilities and reap rich rewards and income with the best yield farming platform. Also, take advantage of the smart contract-driven liquidity pools as well technical expertise with deployment that can help you beat the market competitors easily.   

Yield farmers can benefit from the tailor-made DeFi yield farming solutions and products suited to cater to their diverse requirements. Our experts would dive deep into finding more about your business target audience and create a platform that is in sync with the audience’s requirements and can facilitate smooth and faster DeFi solution deployment. Our developers are familiar with all popular blockchain platforms and understand the nuances of the Smart Contract development and hence they can work towards creating the most comprehensive yield farming platform supporting all Ethereum, EOS, and other tokens and coins.  

By partnering with Prolitus, businesses can leverage the best in blockchain, financial and crypto-economics expertise to help you set up the finest and high-return providing DeFi Yield Farming platform. Connect with us today!

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