Yield farming is a technique to make interest on your cryptocurrencies, much like you would make interest on any money in your savings account. Similar to "staking," yield farming entails locking up your cryptocurrency for a set amount of time in return for interest or other advantages like extra cryptocurrency.
The amount lent when typical loans are made through banks, says Daniel R. Hill, CFP, AIF, president of Hill Wealth Strategies, "is paid back with interest." The concept behind yield farming is the same: bitcoin that is traditionally maintained in an account is lent out in order to generate income.
Since the inception of the practice of yield farming in 2020, annual percentage yields (APY) that can reach triple digits have been produced by yield farmers. This potential return entails a high risk because the protocols and coins created are vulnerable to extreme volatility and rug pulls, in which founders abandon a project and take investors' money.
Understanding DeFi Yield Farming
Using a decentralized application, or dApp, yield farming, also known as liquidity farming, enables an investor to stake their coins by putting them into a lending protocol. The coins can then be borrowed by other investors through the dApp, and they can use them for speculation in an effort to profit from unexpected changes in the market value of the coin.
Yield farming is essentially a rewards scheme for early adopters, according to Jay Kurahashi-Sofue, vice president of marketing at Ava Labs, a company supporting the development of the Avalanche public blockchain that works with several DeFi applications that provide yield farming.
People are encouraged to contribute liquidity via blockchain-based applications by staking or locking up their coins. According to Hill, staking occurs when centralized cryptocurrency platforms gather user deposits and lend them to people who need credit. "Depositors receive a portion of the interest paid by creditors, while the bank retains the balance."
According to Brian Dechesare, former investment banker and CEO of financial career site Breaking Into Wall Street, "This lending is typically facilitated by smart contracts, which are effectively simply a piece of code running on a blockchain, operating as a liquidity pool." Yield farming users sometimes referred to as liquidity providers, lend their money by adding it to a smart contract.
The true benefit of the arrangement is that investors who lock up their cryptocurrency coins on the yield-farming system can earn interest and frequently more cryptocurrency currencies. The investor's returns increase if the value of those extra coins increases.
According to Kurahashi-Sofue, this procedure offers the liquidity that recently released blockchain applications require to maintain long-term growth. According to Kurahashi-Sofue, "[These apps] can] safeguard this liquidity and boost community involvement by paying users with incentives like their own governance tokens, app transaction fees, and other funds."
You could contrast yield farming with the early years of ride-sharing, says Kurahashi-Sofue. In order to bootstrap growth, he claims, "Uber, Lyft, and other ride-sharing applications offered incentives for early customers who recommended additional users into the platform."
Risks In Defi Yield Farming
Risk abounds when cultivating for yield. Some of these dangers consist of:
Volatility
Volatility An investment is considered volatile if there is significant price volatility within a brief period of time. Your tokens' value could drop or rise while they're locked away.
Fraud
Unintentionally investing their money in dubious ventures or schemes that steal the farmer's entire investment is a risk for yield farmers. According to a CipherTrace analysis, the great majority of the $1.9 billion in crypto crimes in 2020 will actually involve fraud and misappropriation.
Rug pulls
Rug pulls are a particular kind of exit scam in which a cryptocurrency developer collects money from investors for a project before abandoning it and keeping the money. According to the aforementioned CipherTrace analysis, rug pulls and other exit scams—to which yield farmers are particularly vulnerable—were responsible for about 99 percent of the big fraud that took place during the second half of the year.
Smart contract risk
Your bitcoin is in danger because yield farming smart contracts may contain vulnerabilities or be vulnerable to hackers. The majority of yield farming risks, according to Kurahashi-Sofue, are related to the underlying smart contracts. These contracts are becoming more secure thanks to better code vetting and outside audits.
Impermanent loss
Your cryptocurrency's value may increase or decrease while it is being staked, resulting in momentarily unrecognized gains or losses. These profits or losses become irreversible when you withdraw your coins, and if the loss is more than the interest you received, you might have been better off if you had kept your coins open for trading.
Regulatory risk
Cryptocurrency regulation still raises a lot of issues. The SEC has declared that certain digital assets are securities and as such come within its purview, giving it the authority to regulate them. State regulators have already filed cease-and-desist orders against BlockFi, one of the most popular cryptocurrency lending platforms.
Kurahashi-Sofue asserts that using decentralized apps is always risky. "The key is reducing the danger just enough for you to feel confident utilizing them based on your own research. Users should always investigate the application's development team to see if they are transparent and thorough with security audits."
Is Yield Farming Profitable?
Despite the fact that yield farming is undoubtedly risky, it may also be profitable; otherwise, no one would even consider trying it. With regard to different liquidity pools' yearly and daily APYs, CoinMarketCap offers yield-farming rankings. It's simple to locate pools offering yearly APYs in the double digits, and some of them even offer APYs over a thousand percent.
Investors should consider whether the possible profit justifies the risk because many of these items carry a high chance of temporary loss. Smith claims that the profitability of yield farming is still very speculative and unclear, just like investing in cryptocurrencies more broadly. The risk associated with locking up your coins while yielding farming, in his opinion, is significantly greater than the potential reward.
The number of cryptocurrencies you can stake will also affect your overall profit. Dechesare claims that in order for yield farming to be lucrative, it needs thousands of dollars in funding and incredibly sophisticated tactics.
In order to engage in yield farming, you must stake, or lock up, your money in order to earn interest or more bitcoin. "As cryptocurrencies become more well-known, yield farming will spread more widely. It's a fundamental concept that has existed for as long as banks have, and it's simply a digital rendition of making loans to investors at an interest rate in order to make money "Hill asserts.
Conclusion
Defi Yield farming is extremely risky even if it has the potential to yield great benefits. A lot can happen while your bitcoin is locked up, as evidenced by the countless instances of recognized fast price changes in the cryptocurrency markets. As with anything in life, if something seems too good to be true, it probably is. Kurahashi-Sofue It is best to have a complete awareness of all the dangers and hazards before engaging in yield farming.
To reap more benefits from this opportunity you need to make a contact with the best DeFi Yield Farming development company to utilize their services for your business, which will help to you generate more revenue.