Let’s say an investor owns coins like ether (ETH) or stablecoins like DAI. Instead of letting these assets sit idle in their crypto wallet, they can put their coins to work by lending or depositing them on various DeFi platforms. These DeFi platforms can be decentralized exchanges (DEX), lending and borrowing platforms, yield aggregators, liquidity protocols, or options and derivatives protocols. Yet another way to generate extra returns on your crypto assets is by becoming a liquidity provider for a decentralized exchange. When someone goes to Uniswap to exchange their Ether for DAI, for example, Uniswap will take some DAI from the liquidity pool and add the Ether the user is exchanging. That allows Uniswap to offer exchanges for just about any cryptocurrency pair you can imagine without having to hold any crypto itself.
- When there are high APYs or APRs offered, this usually means that there is low liquidity in the pool.
- Yield farming typically involves locking up a user’s funds for a specific period of time.
- Yield farmers typically rely on DEXs to lend, borrow, or stake coins—an exercise that allows them to earn interest and speculate on price swings.
- Yield farming, also known as liquidity mining, refers to the lending or staking of cryptocurrency in decentralized finance (DeFi) protocols to earn additional tokens as a reward.
Compound is an algorithmic money market that allows users to lend and borrow assets. Anyone with an Ethereum wallet can contribute assets to Compound’s liquidity pool and earn rewards that begin compounding immediately. Traders need to pay trading fees for using the liquidity pool; the fees are then divided between all liquidity providers based on the respective liquidity amount in the pool. Participants can also earn the platform’s governance token as an additional incentive in certain pools. Impermanent loss as a liquidity provider is a key concept to understand. If the price of one part of the pair moves significantly relative to the other part, you will face impermanent loss.
Uniswap is a decentralized exchange (DEX) protocol that enables trustless token swaps. In exchange for providing liquidity, LPs earn fees from the trades that occur in their pool. Maker is a decentralized credit platform that supports the creation of DAI, a stablecoin algorithmically pegged to the value of USD.
Protocol risks
Like going to several different grocery stores to get the best price for each item on your shopping list, this method can get you a better deal, but it requires time and effort. This differs from centralized exchanges, which match buyers with sellers to discover prices and carry out trades. Liquidity pools provide the financial backing behind these algorithms, enabling a customer’s transaction to be fulfilled upon request.
This often invites a comparison to the interest rate you might earn on a savings account at a bank. Yield farming is a high-risk investment strategy in which the investor provides liquidity and stakes, lends, or borrows cryptocurrency assets on a DeFi platform to earn a higher return. If the prices of the deposited tokens diverge significantly during the farming period, liquidity providers may experience a loss when they withdraw their assets from the pool.
Yield farming promotes financial inclusion by allowing anyone with an internet connection and cryptocurrency to participate in the DeFi revolution. It provides an alternative to traditional financial systems, giving individuals greater control over their funds and the ability to earn passive income. Curve Finance is a decentralized exchange protocol designed specifically for efficient stablecoin swaps. Curve aims to allow users to make large stablecoin swaps with relatively low slippage. The estimated yield farming returns are usually calculated on an annualized basis. This is an estimate of the returns an investor can expect over a year.
Join our free newsletter for daily crypto updates!
Next up is yearn.finance, which works to move users’ funds between different lending and liquidity protocols (Compound, Aave and dYdX) to get the best interest rates. The easiest way to be a staker and to start earning staking rewards is by doing so through a crypto exchange like Coinbase. On proof-of-stake (PoS) blockchains, the user receives interest if they pledge their tokens to the network as a safety measure.
You may refer to our previous yield farming guides on Solana, Polygon, and BSC for more information. Yield farming is a process where you stake or lend your crypto assets to generate high rewards in the form of additional cryptocurrencies. Yield farming as a lender javascript function will require you to use a DeFi protocol such as Compound or Aave. When you want to lend, you exchange the tokens you want to lend for their equivalent tokens. The exchange rate on those tokens is constantly improving as loans collect interest from borrowers.
Lido Staked SOL
They allow P2P trading of digital currencies without the need for an exchange authority to facilitate the transactions. Here’s a simple illustration of how to yield farm on Sushiswap on the Ethereum network. Annual Percentage Rate (APR) – interest rate earned without compounding interest within the year.
If you decide to put your crypto assets into a lending protocol, you can earn even higher yields. Several lending protocols have emerged to offer crypto holders the ability to access the value of their cryptocurrency holding without having to liquidate their assets and crashing is this time incur taxes. So, to get a loan for $100 worth of a crypto, a borrower may need to put down $200 worth of collateral. The last way we’ll discuss is becoming a liquidity provider for a decentralized exchange — such as Uniswap (UNI 5.07%) or Pancakeswap (CAKE 3.91%).
Yet it is only for the most astute investors who can withstand the downsides, such as volatility, rug pulls, and regulatory risks. Top yield farming who established exchange market for cryptocurrency protocols include Aave, Curve Finance, and Uniswap. Now let’s look at some of the core protocols used in the yield farming ecosystem.
This guide will explain everything you need to know about taxes on crypto trading and income. I’m a technical writer and marketer who has been in crypto since 2017.
Annual Percentage Yield (APY) – interest rate earned with compounding interest within the year. Many or all of the products featured here are from our partners who compensate us. This influences which products we write about and where and how the product appears on a page. The views and opinions expressed by the author are for informational purposes only and do not constitute financial, investment, or other advice.
When there are high APYs or APRs offered, this usually means that there is low liquidity in the pool. It can signify two things – either people have no confidence in the pool or that the distribution of the native token is very high, which will dilute the token supply significantly. The investing information provided on this page is for educational purposes only.
There has been a rise in risky protocols that issue so-called meme tokens with names based on animals and fruit, offering APY returns in the thousands. It is advised to tread carefully with these protocols, as their code is largely unaudited and returns are whim to risks of sudden liquidation due to price volatility. Many of these liquidity pools are convoluted scams which result in “rug pulling,” where the developers withdraw all liquidity from the pool and abscond with funds.
There are a number of DeFi projects currently involved in yield farming. The biggest right now in terms of value locked into smart contracts is Aave, a project that allows users to lend and borrow a number of cryptocurrencies. Reward tokens themselves can also be deposited in liquidity pools, and it’s common practice for people to shift their funds between different protocols to chase higher yields. Yield farming took off in popularity due to its applications, such as in liquidity mining, which is the practice of lending crypto assets to a decentralized exchange in return for incentives. Yield farming was once the largest growth driver of the fledgling DeFi sector, but has lost most of its 2020 hype after the collapse of the TerraUSD stablecoin in May 2022.