DeFi Yield Farming: An Introductory Guide

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Defi Yield Farming

Contents

Introduction:

Since the launch of the first cryptocurrency blockchain, the possibility associated with it has been eternal. One such possibility is the introduction of yield farming – a reward scheme that enables you to get more from decentralized finance (DeFi) –  that gained popularity in 2020. Some years back, a crypto enthusiast could only generate a reward by trading or holding it. Today, the story is different through the power of yield farming. 

Yield farming gives you a new way to generate rewards from crypto. It might be challenging to benefit if you start, or you begin without adequate knowledge about it. Whichever one it is, you don’t have to panic or be scared. You can also benefit from yield farming, and that is why we have written all you need to know about DeFi yield farming below.  

What Is Defi Yield Farming And How Does It Work?

Yield farming is a process where you get rewards from your cryptocurrency by investing it in a DeFi platform. It is simply a process of allowing your crypto to work for you while you earn passively. Sounds lovely right? Yield farming works like a bank loan, where you are paid interest on the money you lent. You can lend out your crypto or borrow crypto from a platform that supports it in yield farming.

Yield farming operates on smart contracts. The majority of yield farming is on the Ethereum network using the ERC-20 tokens. Yield farming is also on the Binance smart chain.  This is possible because the Binance smart chain is compatible with Ethereum Virtual Machine (EVM) and can also operate with the Ethereum native protocols.

Total Value Locked:

Total value locked (TVL) is the sum of all funds locked in the liquidity pool. This is very important to measure how healthy a yield farming platform is. An increase in the total value locked leads to an increase in the yield farming on a platform. The current TVL for DeFi is approximately 77billion dollars. You can monitor the total value locked through Defi Pulse.

Yield Farm Platforms:

There are various platforms where you can farm tokens. They have the same way of operating, though the reward system might be different. Below are some of the yield platforms that run on the ethereum and Binance smart chain.

Compound:

Compound is an Ethereum based protocol that allows borrowing and lending. The lender provides a loan by providing liquidity in terms of assets in the platform. The lender gets an interest in the loan supplied. The supply and demand of crypto determine the interest generated. The compound has a native token called cTokens used to pay interest for users. cTokens can also be used in other applications. For example, if you deposit 5Eth on the protocol, the system automatically generates 5c-Eth for you with interest. You can redeem your c-Eth for Eth at any time plus your stake. The compound protocol uses any ERC-20 token. The compound protocol also has the advantage of moving or trading the c-Tokens on other decentralized apps (dApps).

Aave:

Aave is a smart contract-based protocol that allows borrowers to borrow loans and lenders to lend. All that is required for a lender to do is put their cryptocurrency funds into the liquidity pool. Collateral in terms of cryptocurrency must be provided to borrow from the aave’s protocol. A borrower can only borrow a fraction of the collateral. It boasts a high annual percentage yield (APY) ranging from 6% to 13% on stable coins such as USDT and USDC. 

PancakeSwap:

PancakeSwap is the leading automated market maker on Binance Smart Chain. Though it is an automated market maker, its yield farming has continued to grow and is one of the most used in BSC. Presently, Pancakeswap has more than 10 pairs of cryptocurrency for yield farming.  

Venus:

Venus is now one of the leading Binance smart chain protocols for borrowing and lending assets. Users deposit cryptocurrencies such as BNB, USDT, USDC, and ETH to earn interest. The interest is helpful for other purposes such as minting venus stablecoin called VAI or used as collateral to borrow.

Autofarm:

Autofarm has a total value locked of 1.3billion dollars. It currently has more than 30 liquidity pools and is very good for farming.

Yearn.finance:

Yearn.finance is a platform that chooses the best platform to make a profit. It takes the user’s fund from one protocol, such as Aave, to the other to make a profit. It has a native token called yToken. All deposited funds are automatically converted to the yToken.

Steps on Starting Yield Farming:

  1. Get crypto that is useful in a particular yield farm platform. Widely accepted crypto coins are ETH, BTC, and stable coins such as USDT, DAI, BUSD, and USDC.
  2. Download decentralized wallets such as Trust wallet or MetaMask wallet. Register as prompted. Make sure you keep your seed phrase or keys very secure.
  3. After installing, send your funds to your wallet.
  4. Go to the dApp section of the wallet to start farming.
  5. If you are a beginner, it is advisable to start with the compound platform. 
  6. On the compound, click the button on the top right-hand corner.
  7. You should connect your wallet, select the wallet you are using, e.g., Trust wallet.
  8. Go to the supply page, and then choose the asset you want to supply and the amount. Then click supply
  9. A page shows the supply annual percentage yield (APY) and the distribution APY. You earn from the APY by depositing on the compound platform.
  10. Confirm the transaction. Note that you need ETH as a gas fee on the compound platform. If you are using a Binance smart chain such as venus, you need BNB as a gas fee.
  11. You can now borrow or lend on the platform. 
  12. Viola, you are now a yield farmer. Simple right? Please give it a try now.

Risk of Yield Farming:

Just like everything that has to do with life, yield farming has its own risk. The higher the risk you take, the more profit you make. It is always advisable not to invest more than you can afford to lose.

Liquidity risk: 

Liquidity risk occurs when the price of your loan is greater than the collateral you deposited. You run into loss if this happens. Liquidity risk is familiar with crypto that has high volatility, such as BCH or ETH.

Smart contract risk:

Defi protocols are open-sourced and can be open to bugs. These bugs can affect the token price, causing a high drop in the price of the token. 

Gas fee:

An increased gas fee occurs on the ethereum smart chain. The increase in eth gas fee has been on the rise, which poses a challenge for an average investor.

Composability risk:

Composability risk is also known as “money legos,” which means that all defi applications and platforms can interact without permission; this means that the whole defi platform relies on each of its building blocks. Naturally, composability should not be a risk but an advantage. It is a risk because if any of the building blocks stops working, the whole platform can be down.

Conclusion:

Decentralized finance is a platform that uses technology to remove the intermediary barrier in carrying out a financial transaction. It is simple to use and very efficient when compared with centralized exchanges like banks. To use Defi, you do not need an identity card, social security number, or a KYC. 

There are risks associated with using the DeFi platforms, and as such, you should ensure you research the platform you are using and invest what you can afford to lose. 

You can also read about Curve finance and Uniswap v3 protocol.

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