Some people like to trade; some people like to yield farm.
Yield farming within the world of decentralized finance (or DeFi) in the crypto-sphere has taken the media by storm over the past year and a half.
DeFi has garnered attention from amateur investors and institutional money alike. The Ethereum website describes it as “an open and global financial system built for the internet age – an alternative to a system that’s opaque, tightly controlled, and held together by decades-old infrastructure and processes.”
And in this field, there is a certain term that you’ll constantly come across as you dig deeper and learn more about the space. It’s a core component of the main attraction to many of the major DeFi projects that you’ll often hear about.
And that term is “yield farming.”
Table of Contents
What is “Yield Farming” anyway?
TL;DR: “Yield farming” is the process of continuously receiving rewards (usually some type of crypto) in exchange for actions such as locking in your crypto on a decentralized platform to provide it with liquidity (staking), or borrowing/lending crypto via a lending protocol.
Yield farming itself grew as a natural progression of the DeFi craze, so if you’re interested in learning more about it, it’s valuable to know from where this groundbreaking passive income strategy originated.
How did yield farming get started? (A brief history of decentralized finance)
A big part of many people’s decision to get into the crypto space was the idea of “decentralization.” The freedom that comes from a system that isn’t owned or governed by a specific individual or group.
DeFi has come through this year almost as the poster-boy for “true decentralization”, with many touting it as the inevitable progression of the crypto space as regulators start to move in on many of the centralized crypto businesses. With this desire to move toward something less susceptible to outside control, developers in the space decided to start making decentralized alternatives to the popular platforms.
Working on top of existing crypto platforms (primarily Ethereum, especially in the beginning), these new platforms would be designed to function autonomously and require no intervention from a third party. This led to the creation of two critical projects in DeFi history:
- Maker – a protocol launched in 2017, which allowed for the creation of a decentralized stable coin and facilitated crypto lending/borrowing.
- EtherDelta – a decentralized exchange (DEX) popularized during the ICO craze in 2017, which allowed for the permissionless trading of Ethereum tokens.
Jump ahead two years from these two projects, and we see a slew of new DeFi projects leading the charge into the decentralized future. Uniswap, Synthetix and Compound are some of the leading projects in the space at this time.
Then, one year later, in what’s known as the “DeFi Summer of 2020,” Compound changed the game with a fresh twist on DeFi. That June, Compound started to give out governance tokens [$COMP] as an incentive for both lenders and borrowers to continue using the platform.
By the end of that month, due to low liquidity and high demand, the COMP token’s market cap shot up to around $800M (dropping back down over 50% within the next year)! In fact, it had become so lucrative at a certain point, that borrowers were making a profit from their COMP rewards when they borrowed on the platform.
The mania quickly subsided, but it wasn’t long before other projects decided to take a page from Compound’s playbook. Names like yearn.finance, Balancer and Aave started to become more popular as these DeFi projects announced plans of issuing their own governance tokens as platform rewards.
This symbiotic relationship of rewarding people for providing crypto assets to keep the protocols functioning came to be known as “liquidity mining” (because these people were providing liquidity for the platforms). Many people, seeing the profit-earning potential here, developed strategies that utilized various protocols to maximize the “yield” (see how it’s coming together now?) that they would get on their investment.
Side note: it may be a bit of a reach, but “farming” could have originally been a reference to the term in the world of gaming. In gaming, “farming” refers to the act of repeating a specific action in order to collect large amounts of a certain good/item over a period of time. In DeFi, “farming” is repeating the protocol requirements in order to get more yield/profit from your investment. Kinda the same thing, right? Or maybe I’m just a nerd. Anyway…
What are the risks in yield farming?
The saying goes “if it sounds too good to be true, it probably is.” Like every other aspect of the crypto market, this applies to yield farming as well.
While yield farming seems pretty straightforward, there are numerous things that can go wrong (real quick), resulting in you possibly losing most, if not all, of your investment’s value.
Let’s take a look at some of the things that can go wrong:
Smart Contract Exploits
In the media from time to time, you may come across headlines that mention “hacks” in the DeFi space that led to millions being “stolen” from the project’s smart contract.
In reality, the smart contract wasn’t “hacked” per se.
Like a lawyer finding a loophole that allows you to get around certain rules of the law, these “hackers” are just people diligent enough to find a way around certain rules of a smart contract.
Yes, “code is law” may be true… but the code may not be perfect, because it was written by a human that wasn’t perfect.
Like every other subset of the crypto-sphere, we inevitably always see some form of government intervention in the space’s operations.
Under the guise of “the public’s best interests” and “the safety of the general public,” the government (after years of flippantly dismissing the entire space, might I add) seems to be developing this habit of creating laws that stifle innovation while expanding their influence. One day, the government could wake up and decide that operating on your favorite DeFi platform is now illegal. Or, they could arrest some crypto developers and blacklist one of your primary crypto assets in your country.
While these are extreme examples, they are all still in the realm of possibility (we know this, because things like this have been happening for years).
As it is with anything that involves money, there are scammers waiting to make some easy money off of unsuspecting victims.
The most popular in the DeFi space this past year has been the notorious “rug pull,” where the scammer convinces you to provide liquidity for the platform, then, after getting a certain amount of your crypto, they “pull out” all of their liquidity, leaving you holding the bag of now “worthless” assets (re: impermanent loss).
As described in the impermanent loss video above, there is nearly always the risk of your less liquid asset in the yield farming pool you’ve contributed to losing value or popularity within the pool. This could lead to you losing value in that token, and you may have been better off just holding the underlying asset without contributing to the liquidity pool.
As a general best practice, it’s always best to yield farm cryptocurrencies that are highly liquid! Be sure to check out the total value locked in each liquidity pool before yield farming to minimize your risk to impermanent loss.
Just like everything else in the crypto space, if you decide to participate in the DeFi space, you should always move with caution and make sure to do your own research before investing your money.
Don’t get it twisted: it’s still the Wild West out here.
What can we expect of the future of yield farming?
The crypto space is constantly growing and evolving, and the more people that enter the space, the faster this expansion happens. Yield farming in the DeFi space has seen a huge uptick in activity over the past year and is showing no signs of slowing down in the near future.
Where will the space go next, though?
A great question that, like every other question in crypto, can’t be answered with certainty. We have to be completely honest in this space: no one knows anything for sure. The future is unpredictable and the crypto space is so fast-paced that millions of things can happen in the span of a minute.
For the time being, yield farming is one of crypto’s many high-risk, high-reward opportunities. With adequate research and preparation, farmers can find great success leveraging these different DeFi projects.
However, many people feel that, although the space will still be here when the smoke clears, the hype and ridiculously high yields that many farmers are able to obtain will eventually die down to “reasonable” levels as the field stabilizes. We’ve already started to see signs of this as the once super high APY/APR offers of many popular crypto lending platforms have dropped by over 50% over the past year as more people entered the space.
The truth is this: while a few of today’s popular DeFi projects will be here for the long haul, many of the projects that exist today will more than likely be nothing more than a memory within the next 2 years.
This is in no way meant to discourage you from experimenting and participating in yield farming though. In fact, this is more of an encouragement to diligently do your research as you move through these DeFi spaces.
At its core, the space is focused on creating a place for completely decentralized opportunities in finance for everyone to use, so the developers will keep coming up with new ways to incentivize people to participate in the maintenance of these platforms. With adequate research done ahead of time, you can stay ahead of the trends and maximize the incentives that these developers create as the space continues to evolve..
The future of yield farming looks bright.. just probably not as flashy as it does today.
How to learn more about yield farming
This is the easy part (shameless plug time).
As we’ve stated before, we recently developed a Masterclass that touches on everything that we’ve learned in our years in the crypto space – one of those things being effective yield farming strategies.
If you’re interested in building a solid foundation of crypto knowledge for you to safely explore this space as it grows and changes, then we have both a “Beginner Edition” and an “Expert Edition” for the varying levels of experience that people may have.
For those who just wanted to get some solid info on yield farming and strategies in the DeFi space though, we’ve set aside a special “Yield Farming (a la carte)” course that touches exclusively on this topic and goes in depth into the info that you’ll need to navigate the DeFi space.
So if you’re trying to get the best start that you can get, or just want to fortify the knowledge that you already have on these topics, you already know where to go.
Have any questions in the meantime? Contact us here.
Happy Crypto Hunting.