July 26, 2021
5 min read

How DeFi Yield Farming Can Make You Great Crypto Money

Are you 'Yield farming'? If not, you're leaving money on the table. Literally. Read on to learn more about how you can earn interest off your crypto.

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With cryptocurrency, one must keep abreast of new developments or risk obsolescence. Among the latest trends in crypto is yield farming crypto, a reward system taking the crypto world by storm. Yield farming is attracting both experienced and novice crypto investors in DeFi. But what exactly is DeFi yield farming? How does it work? We answer these questions and reveal strategies to maximize yield next.

What is Yield Farming?

Yield Farming in crypto is a process allowing cryptocurrency holders to lock up their tokens to earn interest. Interest is locked up via smart contracts and is either fixed or variable depending on the lock-up agreement. In simpler terms, Yield Farming is like lending crypto to DeFi protocols to get returns.

How Yield Farming Works

The yield farming process is straightforward and takes place in the following three steps:

  1. Identify a liquidity pool, which is like smart contracts containing funds. These pools are financial hubs where users borrow, lend, or exchange tokens.
  2. Add tokens to the liquidity pools. The goal of adding funds to liquidity pools is to provide liquidity to these marketplaces to support economic activity.
  3. Earn rewards (mostly crypto) based on the amount in lock-up—fees generated from DeFi transactions from the underlying platform reward you for providing liquidity to the platform.
  4. Some of the best-known and practical crypto lending platforms can be viewed here.

Liquidity providers can deposit their earned rewards in the same pools or in different pools to earn a higher annual percentage yield (APY). It is common for liquidity providers to shift their cryptocurrencies amongst different DeFi pools and protocols to maximize crypto yield farming. The complexity in yield farming truly begins once you start moving your crypto amongst the various pools.

For instance, if pool A is offering 12% APY for $QPS, and pool B is charging an APR of 7% of $QPS, the best option for maximum yield is to borrow from protocol B at 7% APR, and lend to protocol A, earning 5% of the amount borrowed in the process.

Another example is in trading pairs. You have to take care of the potential impermanent loss arising from unstable pairings; however, there is a probability of maximizing your yield by taking calculated risks. For instance, protocols pair unknown assets with known assets to generate some buzz around the upcoming digital assets. The APY is high for such pairings, some going well over 250%. In such cases, rewards are given in the form of the unknown digital asset.

As an example, pool A offering an APY of 500% for a BTC-POI trading pair is an attractive offer, but are you willing to take the risk of amassing a useless digital token? Or do you know an exchange with a good rate for $POI or another pool offering a lucrative 10% APY on a POI-ETH pair, with ETH as the reward token? Such is kind of the token movements one has to practice to maximize their yield farming.

The Risks of Yield Farming

Picture this, a bank with open doors and a “Free Money” sign at the front entrance. You can visualize the hazards created in such a scenario. Applying it to yield farming, there are risks associated with the alternative income stream.

Because it’s free income, everyone is yield farming crypto. Bad actors enthuse about such numbers and rich pools, which creates a theft risk for smart contracts. Liquidity providers can lose everything through stolen smart contracts. The other type of risk is impermanent loss.

Impermanent loss arises from cryptocurrency price fluctuations where the price at the time of withdrawal is lower than the price at the time of liquidity provision. The market volatility seen in crypto makes impermanent loss a high risk for liquidity providers. It essentially goes unrecognized; most liquidity providers will overlook impermanent losses as they happen. Aside from the risks mentioned, traders/liquidity providers (LP’s) must also be wary of rug pull events and hacks perpetrated by bad actors either internally or externally. Additionally, liquidity providers cannot ignore gas fees.

No yield is 100% guaranteed as a result of these risks. Therefore, liquidity providers must account for every possible variable when calculating the expected benefits from yield farming DeFi.

Best Strategies for Maximum DeFi Yield Farming Profits

Profiting from Yield Farming is mainly dependent on the risk one is willing to take. The goal is to gain maximum APY from the liquidity provided. Here are some of the best strategies liquidity providers can use.

  1. Yield farming using low-risk pairings. Platforms have different coin pairings to match market demand. One of the safest ways to earn a decent APY with limited risk to losses is by using a dual stablecoin pairing. Because both coins are pegged to the USD, there is minimal price fluctuation, limiting exposure to impermanent loss.
  2. High-risk yield farming for maximum profits. For higher APY, liquidity providers are exposed to increased risks. Most high-risk pairings involve new tokens with unstable coin prices. With a proper assessment of market factors, risk-reward scenarios, and a bit of luck, liquidity providers gain maximum yields from these kinds of pairings.
  3. Shifting assets amongst pools. A key strategy for professional yield farmers, shifting assets amongst different pools may lead to the highest APY. However, liquidity providers must be wary of the cost of moving around cryptocurrencies and keep an eye on gas costs to increase yield.
  4. Identifying a suitable platform. Many platforms provide yield farming, with the majority having low to moderate APY returns. Identifying the right platform for your intended token pairing is one of the best ways of getting maximum APY from your portfolio. Depending on your yield farming level, your platform of choice will play a pivotal role in determining your yield farming success.

For instance, Relite, a DeFi yield farming provider, is tailored to meet demands for both novices and professionals in yield farming. It will also soon provide some of the highest APY rates in the market because it’s connecting liquidity cross-chain.

To purchase tokens for liquidity pools, NerdWallet offers an easy guide on buying DeFi coins and options on where to get the best DeFi coin price.

Cross-chain Yield Farming is the next highest returns strategy

The individuals farming cryptocurrencies are constantly seeking the best DeFi yield returns; this means a steady stream of the continual evolution of strategies related to yield farming and the changing of DeFi yield farming returns.

The next stage in DeFi yield farming returns is farming through cross-chain platforms. This is where Relite comes to the fore. Relite’s functionality to allow cross-chain services means that DeFi farmers are not restricted to yield farming strictly via single platforms - whether Ethereum, Binance Smart Chain, or elsewhere. This new freedom in the execution of DeFi yield farming translates to higher-yield returns and lower costs, ensuring those yield farming DeFi tokens are very happy with their crops!

Yield farming is lending your crypto to earn rewards. It works by simply depositing crypto in a liquidity pool for a defined period, then earning rewards after the period elapses. There are associated risks such as impermanent loss; nevertheless, you can earn decent APY by choosing the correct yield farming strategy. One of the best strategies is selecting a suitable DeFi yield farming platform.

Frequently Asked Questions (FAQs) 

What is DeFi Yield Farming?  Yield Farming is a process allowing cryptocurrency holders to lock up their tokens to earn interest. Say you own $ETH; you can deposit it in a pool for a defined or undefined period and earn from your deposit periodically.  

What is Yield Farming vs. Staking? Yield farming is a model allowing cryptocurrency holders to lock up their tokens and earn interest. In contrast, staking is a model derived from the Proof of Stake mechanism where stakers lock up their assets to act as nodes and validate blocks in a platform. 

Is yield farming profitable? Yes, yield farming is profitable, with the profits dependent on the APY. With the right strategies, you can maximize your profits with whatever crypto holdings you have. 

How do I start crypto yield farming? Depending on the platform, the requirements are diverse; however, having a crypto wallet compatible with a yield farming platform is a pivotal first step. 

How does crypto yield farming work? The process is quite simple. Deposit crypto into a liquidity pool of your choice and earn rewards from your cryptocurrency. 

Can you lose money yield farming? As with any investment, there are risks. In yield farming, impermanent loss is one of the frequent risks lenders face. Others include liquidation risk and smart contract risk. 

Why are DeFi yields so high? Various factors are driving and maintaining DeFi yields high. These include: 

  • Real-world uses (traders demanding DeFi loans)
  • Demand for governance tokens
  • Increased protocol activity.

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