Stablecoin Yield Farming: What It Is and How It Works
Published May 22, 2022.
What Are Stable Coins?
If you’ve dabbled in the cryptocurrency world, you’ve probably heard the term stablecoins get thrown around here and there. In simple terms, stablecoins are cryptocurrencies that have their value fixed (i.e., pegged) to another asset (in most cases, a physical one). For example, USDT (known as Tether) has its value pegged to the US dollar, while PAX Gold (going under the symbol PAXG) has its value pegged to the precious metal gold.
So far, stablecoins have been a valuable invention for the crypto world. They decrease the need for operating with fiat cash and make it significantly easier to buy, sell, or trade crypto with fiat money. It's worth mentioning that as of May 2022, many stablecoins have now lost their peg (i.e., are no longer fixed to an asset), so only the best ones like Tether and USD Coin have remained firm.
Now with the basics out of the way, let’s take a simple example of how stablecoins are useful. If you want to send someone $500 with Ethereum, its price might fall by 2% by the time you buy it and an additional 3% by the time the recipient receives it. So, the recipient gets approximately 5% less money than expected. With USDT (Tether), you’ll pay $500, get 500 USDT, and the recipient will receive 500 USDT. Let’s take a deeper dive into the world of stablecoins.
What Is Stablecoin Yield Farming?
Yield farming is a relatively new way of earning money that has risen to popularity thanks to DeFi platforms. In a yield farm, users give out their crypto for others to borrow and earn interest. Usually, yield farms are available on decentralized applications running on the blockchain (dApps).
So far, the DeFi space has made yield farming available in 3 different ways:
- Liquidity providing A lender deposits two cryptocurrencies at a decentralized exchange and provides liquidity. Then, the exchange charges a small fee when other users want to exchange the two coins, giving it to the liquidity provider as a reward.
- Lending With smart contracts, people can take stablecoin loans and receive interest as a reward.
- Staking Staking is quite similar to providing liquidity, though staking is more often used as a way to provide more security in a network. Solana, Polkadot, Ampleforth, and Cardano are some of the most popular coins that use staking as their main algorithm.
How Does Stablecoin Yield Farming Work?
The concept behind yield farms is quite easy to understand, and there’s nothing suspicious happening in the background. Yield farming is generally based on the automated market maker model (AMM), which involves liquidity providers (see above), liquidity pools, and borrowers. Let’s dive deeper into how it works.
Firstly, liquidity providers (or “lenders”) deposit their stablecoins into a liquidity pool. As we mentioned above, a liquidity pool is a place where users can borrow and exchange stablecoins for a small fee (which is then given to the lender).
So, how to yield farm with stablecoins? It's relatively easy - you can find stablecoin yield farms at many popular exchanges, like Binance, Coinbase, PancakeSwap, or SushiSwap. These yield farms usually have their precise returns written down as an annualized percentage rate (APR). Normally, the return you can expect from a yield farm depends on the exchange, though for stablecoins, the returns are usually 10-14% yearly, as long as you're ready to carry the risks of yield farming.
How Do You Profit From Stablecoins?
Now that you’ve got the hang of stablecoins and yield farms, you can probably start to paint a picture in your head of how holding them can be profitable. There are many ways to earn a profit with stablecoins, though we will go over the three easiest & most popular ones:
Earning Interest at an Exchange
With exchanges like KuCoin, Coinbase, and Binance, you can put your stablecoins in a special wallet where other users can temporarily take them as a loan. At these platforms, interest is usually paid out daily, and it’s primarily done with USDT (Tether) and USDC (USD Coin).
Lending on Your Own
When you’re lending stablecoins at an exchange, the exchange will always take a small percentage of all the transactions you make as a fee, including your earned interest. Even though it’s more profitable than lending at an exchange, you’ll have to carry the risks of lending all on your own. This means researching lending outlets for stablecoins and handling the paperwork manually.
Staking Your Stablecoins
We briefly explained what staking is and how it works above. With staking, you’ll lock your stablecoins in a special wallet (or node) and earn interest while it’s there. However, keep in mind that you cannot access the coins while they’re staked. As is the case with most staking mechanics, the only way you'll be able to access your stablecoins before the “locked date” is by forfeiting your already-earned interest.