Yield Farming in Decentralized Finance (DeFi): What you need to know
Yield farming is an investing strategy involving staking or locking up your crypto assets in exchange for interest or more cryptocurrency. Simply put, Yield farming is a way to make more crypto with your crypto, the reward percentage could reach triple digits. Sweet, right?
What is yield farming?
Yield farming is a means of earning interest on your cryptocurrency, similar to how you’d earn interest on any money in your savings account. And similarly to depositing money in a bank, yield farming involves locking up your cryptocurrency, for a while in exchange for interest or other rewards, such as more cryptocurrency.
Yield farming, also referred to as liquidity mining, in some sense can be paralleled with staking. In many cases, it works with users called liquidity providers (LPs) that add funds to liquidity pools.
Liquidity pool basically is a smart contract that contains funds. In return for providing liquidity to the pool, LPs get a reward. That reward may come from fees generated by the Defi platform, or some other source.
Some liquidity pools pay their rewards in multiple tokens. Those reward tokens then may be deposited to other liquidity pools to earn rewards there, and so on.
You can already see how incredibly complex strategies can emerge quite quickly. But the basic idea is that a liquidity provider deposits funds into a liquidity pool and earns rewards in return.
Since yield farming began in 2020, yield farmers have earned returns in the form of annual percentage yields (APY) that can reach triple digits. But keep in mind that high reward comes at high risk.
How does it work?
Yield farming is closely related to a model called automated market maker (AMM). It typically involves liquidity providers (LPs) and liquidity pools.
Liquidity providers deposit funds into a liquidity pool. This pool powers a marketplace where users can lend, borrow, or exchange tokens. The usage of these platforms incurs fees, which are then paid out to liquidity providers according to their share of the liquidity pool.
However, the implementations can be vastly different. Another incentive to add funds to a liquidity pool could be the distribution of a new token. For example, there may not be a way to buy a token on the open market, only in small amounts. On the other hand, it may be accumulated by providing liquidity to a specific pool.
The rules of distribution will all depend on the unique implementation of the protocol. The bottom line is that liquidity providers get a return based on the amount of liquidity they are providing to the pool.
Typically, the estimated yield farming returns are calculated annualized. This estimates the returns that you could expect over the course of a year. Some commonly used metrics are Annual Percentage Rate (APR) and Annual Percentage Yield (APY). The difference between them is that APR doesn’t take into account the effect of compounding, while APY does. Compounding, in this case, means directly reinvesting profits to generate more returns.
What are the risks?
Yield farming isn’t simple. The most profitable yield farming strategies are highly complex and only recommended for advanced users.
Yield farming is teeming with risk. Some of these risks include:
- Volatility: Volatility is the degree to which an investment’s price fluctuates. A volatile investment experiences a lot of price movement in a short period. The price of your tokens could crash or surge while they’re locked up.
- Fraud: Yield farmers may unwittingly put their coins into fraudulent projects or schemes that make off with all of the farmer’s coins.
- Rug pulls: Rug pulls are a type of exit scam where a cryptocurrency developer gathers investor funds for a project then abandons the project without returning investors’ funds.
- Smart contract risk: The smart contracts used in yield farming can have bugs or be susceptible to hacking, putting your cryptocurrency at risk. Better code vetting and third party audits are improving the security.
- Impermanent loss: The value of your cryptocurrency could rise or fall while it is staked, creating temporarily unrealized gains or losses. These gains or losses become permanent when you withdraw your coins, and may result in you having been better off if you’d kept your coins available to trade if the loss is greater than the interest you earned.
In a nutshell, Yield Farming is a way to make more crypto with your crypto and it’s possible to earn high returns with yield farming, but it is also high risk.
MetaPoo’s Yield Farming platform is one of our main tools to primarily incentivize Liquidity Providers, by rewarding them with our native token, MTP. Our Yield Farming platform is also support NFT Staking. By stake NFTs from Poo Series to farming pools, users can further increase the reward receive.
MetaPoo will become the fastest growing DEX on Solana, so the more liquidity stay on our DEX, the more users can trade without worrying about slippage.