Crypto is a form of money. So far, it has been the internet's money. It is for this reason that some developers believed that it should in some ways be governed like the money in banks. This as a whole was the concept behind Decentralized Finance (Defi).
Yield farming also referred to as "liquid mining" is using crypto assets to generate more crypto assets. Simply, by staking or lending owned crypto for returns in the form of more crypto assets. One of Defi products, this has been the most profitable one. And as the industry has grown, investors (liquid providers) have found complex strategies to make more money by moving crypto in between different platforms (Liquid pools) to maximise profits.
Yield farming began trending in 2017 with the explosion of Defi. It was however not until 2020 when it became a household term. The practice has been credited for the Defi frenzy in the last few years that has seen the industry balloon from a market cap of $500 million to $10 billion. It was especially exciting not only for its impressive returns but because it was outperforming Bitocin for most of 2019 and 2020, while the world's largest crypto was stuck in a three-year bear market. Some of the early platforms to fully implement yield farming were Compound and Aave. Later, the competition got steep and has left the likes of Yearn.Finance,UniSwap and MakerDAO on top. These platforms' goal is to use yield farming to bring an openly accessible finance ecosystem to the masses.
Across the different platforms, users can lend, borrow or exchange tokens. Normally, the lenders bring liquidity to the pool while the borrowers provide collateral. Borrowers risk being liquidated if they default or over-collateralize.
Most Defi protocols are issued on the Ethereum network which has seen Ethereum become the king of not only smart contracts but Defi as well. More recently others such as Tron and Binance have added the feature. Additionally, through side chains, some protocols are gaining autonomy. Some of these protocols offer governance tokens for liquidity mining. This was first executed by Compound which offered COMP as an additional reward to users. Some of these governance tokens have become so popular that they are traded on crypto exchanges.
These protocols incentivize crypto asset holders to lock or lend their assets in a smart contract-based liquidity pool. Some of the incentives include transaction fees, interest percentage from lenders and governance tokens. The returns are demonstrated in an annual percentage yield (APY) much like banks do with deposits.
Risks and Rewards Of Yield Farming
With new products and especially those created within developing technology, there are massive rewards for being an early adopter. but equally, significant risks. The biggest risk has been hacking and bugs in the protocol. Much like centralized exchanges, which are under constant attacks, yield farming protocols are under constant attacks. Recent attacks have seen millions lost permanently. Some of these include Yam protocol and Harvest.Finance, which lost $20 million due o a liquidity hack. Bugs are also common since the protocols are written by small teams of developers.
Its also been hard for the average user to fully understand these protocols. A lack of understanding makes users susceptible to a bad investment. On top of this, with the rise of yield farming platforms, potential users have had to be keen not to get into illegitimate platforms.
One of the most popular ways that scammers have stolen from users is through a method referred to as a 'rug plug'. This is when the Defi team of developers siphon the pools in which lenders and depositors store crypto assets. It is a form of exit scam. The most recent fiasco is the Defi project TurtleDex built on the Binance chain. In this instance, which took place earlier in the year, they made away with 9,000 BNB equivalent to $2.4 million at the time.
For some of the protocols built upon Ethereum, they have further suffered due to high gas fees which have been a menace on the project in recent years. These high fees have had an effect on both prices and speed in the respective protocols.
The Defi ecosystem continues to grow and yield farming is setting the pace. While its not in the limelight as before, its development continues to be integral to the future of crypto and evolution of finance as a whole.