Yield and Liquidity Farming - Tools to Generate Alpha in the Crypto Space

DeFi or decentralised finance is the new talk of the town with the disruptive application of the blockchain technology keeping the cryptocurrency ablaze in the market.

Blockchain technology is behind almost every DeFi application in the market place, aiming to take out the involvement of third party in financial transactions.

The concept of financial liberty is taking strong roots across the globe, and with that, many new concepts which could be called crypto banking concepts such as “Yield Farming”, “Liquidity Mining” are capturing the eye of the global investing community and of the general public as well.

What is yield farming? How yield farmers trade and generate alpha in the market?

DeFi or the decentralised finance is bringing a new game in the cryptocurrency space with DeFi-led momentum providing a stable base to digital assets such as bitcoin.

DeFi is currently bringing a paradigm shift in the finance filed as unlike a few years back when a central party or a third-party financial institution were at the centre stage of any financial transaction; you do not need a third party to lend, borrow or transact.

To Know More, Do Read: DeFi Led Sentiments Keep Bitcoin Afloat

Furthermore, with more and more financial liberty taking strong roots across the globe, many new concepts which could be called crypto banking concepts such as “Yield Farming”, “Liquidity Mining” are capturing the attention of the global investing community and of the general public as well, as such crypto-related concepts are becoming the new gizmo to make money in the crypto marketplace.

The crypto space is currently a hotshot with a lot of R&D, investment activities, and extreme volatility being par for the course.

One simple way of generating alpha or earning more than the normal price appreciation of the cryptocurrency is to put one’s cryptocurrency on work like how one deployes money on work to earn some extra returns.

In the crypto space, one such method that puts the currency into work is known as Yield Farming.

What is Yield Farming and How it Works?

Yield farming is defined as a strategy of temporarily putting cryptocurrency at the disposal of some DeFi-based start-up application to earn more cryptocurrency.

Before we dive deep into yield farming, one has to understand what is liquidity mining and what are tokens?

In simple words, token are rewards issued by any blockchain start-up, and they either represent ownership in something, like a portion of Uniswap liquidity pool, or access to some service.

Tokens could be used in many ways across the crypto space, but often they are used as a substitute of currency for certain purposes.

Tokens could be of many types, while one type of token is tantamount to money and access to certain services, others such as the governance tokens are entirely different.

Governance tokens are like certificates which give the holder a right to vote on changes to a protocol (i.e., a set of digital guiding principle).

For example, DeFi-based platforms such as MakerDAO – holder of its own governance token MKR, frequently votes over bringing change in parameters which decides the borrowing and lending rate, and other such things.

However, despite what tokens are and what they do, the common things among all types and variety of token is that they all are tradable with a market price.

Broadly speaking, yield farming is any effort put by an investor to generate higher returns possible on digital assets.

But how do they do that?

Well, they trade pool and simply select the pools with the highest annual yield percentage on a frequent basis.

What are Pools and How Yield Farmers Trade?

To better understand pools, let us assume that there are two tokens, i.e., A and B, and both are worth $1 each all the time.

Now assume, there is a decentralised protocol such as Uniswap which shows the price for each token in any pooled market pair on the basis of the balance of each or the quantity of each token in the pool. So, in simple terms, if anyone in the market wants to set a pool for token A and B, they have to deposit an equal quantity in both.

Now for simplicity sake, assume that the decentralised protocol is designed in such a way that the price of these token does not change until the quantity of each token in a paired pool change.

Thus, in a pool with two token A and two token B, the program would offer $1 for each or would issue token A for token B and vice versa as they both are of $1.

But now, imagine an investor enters the market and draws one token B from the pair of two token A and two token B and puts one token A.

So now, the pool has three token A and only one token B, and as the program is guided to keep the pool in balance, it would increase the price of token B eventually so that people in possession of token B could deposit and take the price advantage.

That’s how the liquidity pool works, and why would someone simply be having tokens such as A or B? Because tokens are first of all tradable with a market price and they sometimes provide many access advantages in the crypto space.

So how does a yield farmer trade?

Suppose a yield farmer deposits around ten bitcoin in a lending application such as compound, as a reward he/she would get some reward or token back. Let us assume that the farmer gets ten token C for the same.

The farmer can go ahead and trade those token C in a liquidity pool which pairs up or trade token C with some other token and make a profit.

In a nutshell, this extra effort from the investor to take the token C for lending cryptocurrency and trade it in a liquidity pool is what makes the investor a yield farmer, and the whole process of earning more than just interest on lending the bitcoin is known as yield farming.

Yield and Liquidity Farming - Tools to Generate Alpha in the Crypto Space

DeFi or decentralised finance is the new talk of the town with the disruptive application of the blockchain technology keeping the cryptocurrency ablaze in the market.

Blockchain technology is behind almost every DeFi application in the market place, aiming to take out the involvement of third party in financial transactions.

The concept of financial liberty is taking strong roots across the globe, and with that, many new concepts which could be called crypto banking concepts such as “Yield Farming”, “Liquidity Mining” are capturing the eye of the global investing community and of the general public as well.

What is yield farming? How yield farmers trade and generate alpha in the market?

DeFi or the decentralised finance is bringing a new game in the cryptocurrency space with DeFi-led momentum providing a stable base to digital assets such as bitcoin.

DeFi is currently bringing a paradigm shift in the finance filed as unlike a few years back when a central party or a third-party financial institution were at the centre stage of any financial transaction; you do not need a third party to lend, borrow or transact.

To Know More, Do Read: DeFi Led Sentiments Keep Bitcoin Afloat

Furthermore, with more and more financial liberty taking strong roots across the globe, many new concepts which could be called crypto banking concepts such as “Yield Farming”, “Liquidity Mining” are capturing the attention of the global investing community and of the general public as well, as such crypto-related concepts are becoming the new gizmo to make money in the crypto marketplace.

The crypto space is currently a hotshot with a lot of R&D, investment activities, and extreme volatility being par for the course.

One simple way of generating alpha or earning more than the normal price appreciation of the cryptocurrency is to put one’s cryptocurrency on work like how one deployes money on work to earn some extra returns.

In the crypto space, one such method that puts the currency into work is known as Yield Farming.

What is Yield Farming and How it Works?

Yield farming is defined as a strategy of temporarily putting cryptocurrency at the disposal of some DeFi-based start-up application to earn more cryptocurrency.

Before we dive deep into yield farming, one has to understand what is liquidity mining and what are tokens?

In simple words, token are rewards issued by any blockchain start-up, and they either represent ownership in something, like a portion of Uniswap liquidity pool, or access to some service.

Tokens could be used in many ways across the crypto space, but often they are used as a substitute of currency for certain purposes.

Tokens could be of many types, while one type of token is tantamount to money and access to certain services, others such as the governance tokens are entirely different.

Governance tokens are like certificates which give the holder a right to vote on changes to a protocol (i.e., a set of digital guiding principle).

For example, DeFi-based platforms such as MakerDAO – holder of its own governance token MKR, frequently votes over bringing change in parameters which decides the borrowing and lending rate, and other such things.

However, despite what tokens are and what they do, the common things among all types and variety of token is that they all are tradable with a market price.

Broadly speaking, yield farming is any effort put by an investor to generate higher returns possible on digital assets.

But how do they do that?

Well, they trade pool and simply select the pools with the highest annual yield percentage on a frequent basis.

What are Pools and How Yield Farmers Trade?

To better understand pools, let us assume that there are two tokens, i.e., A and B, and both are worth $1 each all the time.

Now assume, there is a decentralised protocol such as Uniswap which shows the price for each token in any pooled market pair on the basis of the balance of each or the quantity of each token in the pool. So, in simple terms, if anyone in the market wants to set a pool for token A and B, they have to deposit an equal quantity in both.

Now for simplicity sake, assume that the decentralised protocol is designed in such a way that the price of these token does not change until the quantity of each token in a paired pool change.

Thus, in a pool with two token A and two token B, the program would offer $1 for each or would issue token A for token B and vice versa as they both are of $1.

But now, imagine an investor enters the market and draws one token B from the pair of two token A and two token B and puts one token A.

So now, the pool has three token A and only one token B, and as the program is guided to keep the pool in balance, it would increase the price of token B eventually so that people in possession of token B could deposit and take the price advantage.

That’s how the liquidity pool works, and why would someone simply be having tokens such as A or B? Because tokens are first of all tradable with a market price and they sometimes provide many access advantages in the crypto space.

So how does a yield farmer trade?

Suppose a yield farmer deposits around ten bitcoin in a lending application such as compound, as a reward he/she would get some reward or token back. Let us assume that the farmer gets ten token C for the same.

The farmer can go ahead and trade those token C in a liquidity pool which pairs up or trade token C with some other token and make a profit.

In a nutshell, this extra effort from the investor to take the token C for lending cryptocurrency and trade it in a liquidity pool is what makes the investor a yield farmer, and the whole process of earning more than just interest on lending the bitcoin is known as yield farming.

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