What is yield farming? Is it the best way to invest in cryptocurrencies?

Highlights

• In yield farming, the crypto investor can earn good income by lending their crypto holdings
• Yield farming is performed on decentralised finance platforms
• There are a lot of decentralised finance platform through which yield farming can be conducted

Due to the inherent volatility of the crypto market, many crypto traders are now focusing on generating passive income rather than actively trading in cryptocurrency, which can wipe out their entire capital. Yield farming and staking are the two most popular ways to generate passive income from your cryptocurrency investment. In this article we will discuss what is yield farming and how it is different from staking. We will also tell you about some of the platforms that can help you generate solid returns through yield farming.

What is yield farming?

Yield farming is a process through which one can increase his/her crypto holdings by lending them. Now the question that must be striking your mind is "how does this work?". Yield farming is possible because of the growth of decentralised finance (DeFi) platforms, which require huge amount of cryptocurrency to trade/lend/borrow and for conducting other activities on the blockchain. Creating such a huge cryptocurrency pool is not possible with own investments. That is why these DeFi platforms depend on others' crypto holding to perform the above-mentioned activities. These platforms pay interest for using others' cryptocurrencies.

In yield farming crypto investors deposit their cryptocurrencies in liquidity pools, which is used by DeFi platforms to trade, lend, and borrow. Automated market makers also need these pools to offer automated trading services. These liquidity pools enable AMMs to increase trading volume of a coin, hence its value.

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In yield farming, the depositors generally earn crypto tokens for locking in their holdings on DeFi. If the price of these earned tokens rises, the return also increases. Noteworthy here is that vice versa also holds true.

The liquidity provider can make a good profit until fewer people/investors know about it. When more people start depositing their currencies in the liquidity pool, the value of returns starts falling.

By this, we can make out the risks associated with yield farming, such as extreme volatility and rug pulls. Rug pull means that the project developer abandons the projects and runs away with all the funds (since no middleman is involved).

How to begin with yield farming?

There are a lot of DeFi platforms from where you can begin with yield farming. The interest rate on deposits depends upon the demand. Liquidity provider can move their funds across the DeFi platforms to maximise the return.

Here is a list of some yield farming platforms.

Aave: This is a liquidity market protocol where borrowers and depositors can participate. Aave is an open-source protocol through which anyone can interact with the user interface. Moreover, it is secure and has been audited. Here, the transaction fee depends upon the transaction complexity and network status.

Compound: Compound works on the Ethereum blockchain, and here, the interest rate is derived from the demand and supply of the tokens. To ensure a high level of security, it is reviewed and audited.

Curve Finance: Curve Finance is built on the Ethereum blockchain. It claims to use locked funds more efficiently than any other DeFi platform. It offers a large list of stable coin pools.

Suggested reading: What are stablecoins? Top 3 assets by market cap in this category

Which is better yield farming or staking?

Yield farming and staking have garnered many investors’ attention, but both have their own advantages and disadvantages. Staking provides a steady return, while returns from yield farming are volatile and cannot be predicted. In addition to this, the funds are locked in a specific duration (in some projects). However, the risk associated is also greater. There is a risk of high volatility, loss due to security reasons or rug pulls.

Related article: Five crypto platforms in Australia that provide highest staking rewards

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