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Picture this: the cryptocurrency that used sit in your wallet earning nothing can generate returns of 5%, 10%, 25% and beyond. The best part? You don’t need a complex trading strategy. All you need to do is understand yield farming works and how to maximize it.
What is Yield Farming?
Decentralized finance (DeFi) has become one of the most popular use cases in the blockchain ecosystem, providing transparent, accessible and secure financial services to users. DeFi has no centralized authority to provide market-making, lending and borrowing, so these platforms incentivize users with rewards or yields to offer these services. Yield farming refers to the investment strategy of providing these services to DeFi protocols.
Since the successful launch of Compound in 2020, a lending and borrowing platform for cryptocurrency on the Ethereum blockchain, yield farming has gained significant traction. Compound introduced its native token, $COMP, which was awarded to users actively participating in the platform's market-making activities. This period in 2020 was called the DeFi Summer, during which some yield farmers got up to 1,000% returns on their investments. Since then, DeFi’s growth has continued to grow, creating new applications offering competitive rewards to users.
Yield farming has been a massive driver in DeFi’s growth, allowing users to maximize their crypto holdings and helping platforms and protocols run efficiently. On the surface, yield farming seems like a free-money investment strategy, but it does have some risks. Educating yourself on yield farming will enable you to maximize your holdings, which many crypto owners don't know how to do.
How Does Yield Farming Work?
Yield farming works through platforms incentivizing users to provide liquidity and lending services on their platforms since there is no central authority to do so. These incentives are rewards in the form of fees and yields paid directly to you. To automate these processes in a permissionless way, DeFi platforms employ smart contracts, eliminating the need for an intermediary. Some yield farms may seem complicated, but many have a low barrier to entry. To earn these rewards, users take their tokens from brokerages or wallets, move them to a DeFi platform and provide services like liquidity or lending, receiving rewards for doing so. These rewards are commonly measured in the form of Annualized Percent Yields (APYs). When selecting yield farming opportunities, looking at the APY can give you a glimpse into your earning potential.
Types of Yield Farming
There are three main ways to farm yields, each having different mechanisms, risks and rewards. Let's jump into them:
- Providing liquidity: Providing liquidity on DeFi platforms like Uniswap is a popular way to farm yields. Uniswap uses Automated Market Makers (AMMs), which are supported by smart contracts, to facilitate order books. Users in the Uniswap ecosystem can become liquidity providers (LPs) by depositing crypto pairs into a liquidity pool, earning a percentage of transaction fees. Other users use your pools to swap their tokens. Your return depends on the amount deposited into the pool, the fees associated, fluctuations in supply and demand and gas fees.
- Lending: Another popular way to yield farm is to place your crypto in a lending protocol like Aave, where you earn interest on the money lent. Smart contracts facilitate this process by automatically paying lenders their interest and distributing the money to the borrower. As a lender, you are typically given interest payments in a supply token, which then can be exchanged for the underlying token.
- Borrowing: A more speculative and higher risk yield farm strategy is borrowing crypto to provide liquidity or lending of a specific asset. By providing collateral, you can receive borrowed funds to increase your exposure to yield farming opportunities, amplifying risk and reward. Users choose to do this because they may want to keep their assets in a wallet or need to access different cryptocurrencies to provide liquidity or loans. By collateralizing their holdings, they borrow funds to maintain their current position while reaping the rewards of yield farming. This is not advisable for beginners, as doing so dramatically amplifies the risk associated with yield farming.
Benefits of Yield Farming
- Potential for high returns: Yield farming can offer higher returns than traditional investment vehicles, making it attractive for investors.
- Passive income: Yield farming allows you to earn passive income on your crypto holdings because smart contracts do the heavy lifting on the backend. Although you aren’t actively trading your assets, you must still do your due diligence on DeFi platforms and understand how market fluctuations impact your earnings.
- Diversification: Yield farming provides dynamic opportunities to spread your investments across multiple DeFi platforms, potentially decreasing your overall risk exposure and making your money work hard for you.
- Flexibility: Many platforms that support yield farming allow you to withdraw your funds at any time, giving you more control over your assets.
Risks of Yield Farming
- Smart Contract Vulnerabilities: While rare, smart contracts can be vulnerable to hacks, bugs, or exploits. If a smart contract supporting a yield farming platform is hacked, you could lose your investment. To safeguard against this, using platforms with more than $1 to 2 million dollars of total value locked (TVL) is a good option. Protocols with higher TVL require higher security measures, making them less likely to be hacked, but not impossible.
- Impermanent loss: When you provide liquidity to AMMs like Uniswap, you place two tokens into a liquidity pool. If Token A decreases in value, the smart contract supporting the AMM will automatically sell Token B to buy Token A (depreciating coin) to maintain a 50/50 balance (common AMM mechanism). The discrepancy between holding your assets in a wallet versus a liquidity pool is called impermanent loss. Impermanent loss is less frequent in stablecoin pools because prices are less volatile.
- Market volatility: Yield farming returns can decrease based on token price fluctuations, liquidity pool supply and demand, and high gas fees on networks like Ethereum. The APY displayed at first may be lower or higher in the future.
- Scams: Some yield farming platforms use shady tactics to entice investors to deposit money and then run off (rug pull). Due diligence is vital in any investment strategy, and yield farming is no different. Remember that platforms with less than 1 million TVL are less likely to be safe.
Is Yield Farming Still Profitable?
Yes, yield farming is still profitable in 2024. The profitability of yield farming depends on various factors, such as the type of DeFi platform, assets you are farming, and market conditions. Most yields fall between 5% to 50% APY, but returns can sometimes go into the triple digits. Like any investment, yield farms with higher projected returns typically have higher risk. Providing liquidity reigns as the most popular method of yield farming due to the passiveness and control over risk exposure.
Providing liquidity in stablecoin pools is a relatively low-risk strategy to earn extra on your digital assets. Stablecoin liquidity pools are less susceptible to impermanent loss as token prices remain more stable, making it a solid opportunity for beginners to start yield farming. To yield farm successfully, understanding the DeFi ecosystem will be beneficial. Before jumping into a platform and farming, investors should understand the risks and how their returns can change over time.
Where to Yield Farm Crypto
To start yield farming, you must choose a DeFi platform that supports your goals and offers adequate rewards for your investment. Here are some of the top choices among beginner and advanced farmers.
- Uniswap: A DEX on Ethereum that allows users to provide liquidity, earning a share of the trading fees. There are many pools to choose from offering varying returns, making it a great place to start your yield farming journey.
- PancakeSwap: A popular DEX on the Binance Smart Chain (BSC) that offers liquidity-providing opportunities like Uniswap, usually with lower gas fees than Ethereum.
- Curve finance: One of the largest DEX platforms by TVL — utilizing a unique market-making algorithm that benefits liquidity providers and users looking to swap. Curve is notably recognized for its enhanced stablecoin trading capabilities — great for liquidity providers who want a more consistent APY.
- Aave: A decentralized platform allowing users to lend and borrow ERC-20 tokens like ETH in exchange for interest. As a lender, you can earn competitive interest rates on various cryptocurrencies.
uni
Uniswap$13.32*
*prices delayed up to 10 minutes-1.00%
24HDisclosure: eToro USA LLC; Investments are subject to market risk, including the possible loss of principal.
cake
PancakeSwap$2.33*
*prices delayed up to 10 minutes-8.00%
24HDisclosure: eToro USA LLC; Investments are subject to market risk, including the possible loss of principal.
curve
CURVEHASH$0.00013*
*prices delayed up to 10 minutesDisclosure: eToro USA LLC; Investments are subject to market risk, including the possible loss of principal.
aave
Aave$297.18*
*prices delayed up to 10 minutes-10.0%
24HDisclosure: eToro USA LLC; Investments are subject to market risk, including the possible loss of principal.
Yield Farming is Here to Stay
Yield farming has become a popular way for cryptocurrency owners to earn extra income from their holdings. Users can provide liquidity and lending services on DeFi platforms to earn lucrative yields. While yield farming attracts users with passive returns, risks like smart contact vulnerability, impermanent loss, market volatility and scams are possible.
Before diving into yield farming, it is essential to research DeFi platforms and farming strategies thoroughly. According to Yahoo Finance, DeFi’s market cap is expected to reach $230 billion by 2030 with a compound annual growth rate (CAGR) of 46%. Yield farming will continue to grow alongside the DeFi ecosystem, offering new opportunities for investors to maximize their holdings while building the future of decentralized finance.
About Gianluca Miller
Gianluca Miller’s crypto journey started in 2019 when he sought alternative assets to diversify his investment portfolio. With a keen interest in innovative technologies, he became increasingly involved in Web3 through trading crypto and participating in DeFi protocols. Over the last few years, he has become a blockchain evangelist, fascinated with the tech’s utility and impactability. Gianluca contributes to Benzinga, is working on a Defi research project through Blockchain UCSB, and continues to expand his Web3 acumen daily. He loves learning, analyzing new projects and market conditions, and building relationships with industry leaders.