The Basics of Yield Farming Strategies

By 

Josiah Makori

 on May 31, 2022. 
Reviewed by 

Romi Hector

Two Bitcoins on a stack of coins with a gold background

In the simplest terms, yield farming is a decentralized finance (DeFi) investment strategy that allows you to lend your digital assets and earn returns (yield). Sometimes known as liquidity mining, yield farmers put their money to use and generate profits.

The crypto community has this common perception that the key to holding digital assets as a long-term investment is leaving them idle in a cold wallet. Yield farming changes this old way of thinking. It enables you to put your crypto to work and earn more value.

So, how do you earn yield with the crypto in your digital wallet? By lending them out!

When you lend your assets to a DeFi protocol’s liquidity pool, you earn money from your deposits plus a reward token (normally the native currency of the platform).

The Difference Between Yield Farming and Staking

As mentioned earlier, yield farming is an investment strategy that allows you to lend your digital assets and earn returns. On the other hand, staking is an investment strategy that involves supporting a proof-of-stake (PoS) blockchain and confirming transactions by locking your digital assets on that network.

In the debate of yield farming vs. staking, yield farming shares many similarities with staking since they both apply the concept of holding assets to earn rewards. Some people strongly feel that staking is part of yield farming. While these two terms are often used interchangeably, they differ in many ways. Here are some of those ways:

Complexity

Staking is the more straightforward method of generating profits since you only need to choose the staking pool and lock your assets. Yield farming is a bit complex as you must select the coins for the platform to use, not forgetting the probability of regularly swapping platforms or assets.

While yield farming is more complex than staking, it generates better returns when you have the proper management knowledge.

Risk Levels

Often, yield farming is done on newly launched DeFi companies that are highly susceptible to rug pulls and the accompanying risks of startups. Staking is more common in projects that have established their PoS chains. Rug pulls are rare occurrences on such networks.

Volatility risk applies to yield farming and staking since stakers and yield farmers can make losses when asset prices drop suddenly.

Impermanent Loss

Yield farming exposes you to impermanent loss because of price variations when you lock your assets. For instance, when you deposit assets to a liquidity pool and their value appreciates, you would have benefited more if the assets were in your wallet by taking profits. The same is true when they drop in value. Impermanent loss is not applicable in staking.

Profitability

Since yield farmers primarily invest in early startups, they will likely generate high profits. According to CoinGecko, yield farming returns vary from 1-1,000% Annual Percentage Yield (APY). On the contrary, staking has stable APY returns ranging from 5% to 14%.

Duration

Staking requires users to lock up their assets for a certain period to earn returns. Yield farming doesn’t necessarily need farmers to lock funds for certain periods.

Transaction Costs

Yield farmers may be prompted to switch from one pool to another in search of more fertile grounds. However, they incur gas fees in the process. PoS stakers don’t solve complex math puzzles to receive rewards like in proof-of-work (PoW) blockchains. Therefore, staking and maintenance costs are lower.

Yield Farming Strategies

Here are the best yield farming strategies to earn more rewards.

Operating Networks

As a yield farmer, you can allocate your digital assets to high-quality validators, enabling the networks to function more effectively and securely. Rewards are paid by blockchain users who pay validators network fees for validating the network. Validators then remit a certain percentage of those fees back to the farmers.

Lending

As a yield farmer, you can assign some funds to capital-constrained traders, enabling them to discover asset prices more effectively. You can also offer value by giving some of your funds to higher-quality borrowers and crypto projects. In both cases, you are rewarded by borrowers who are charged regular interest by lending protocols.

Liquidity

Yield farmers offer liquidity to individuals who need it, enabling them to enter and exit positions with negligible market impacts. Automated Market Makers (AMMs) issue direct rewards (trading fees and spreads) to liquidity providers. These rewards are obtained from users who borrow liquidity from liquidity pools.

Management and Governance

You can create surplus via more effective management protocols like Convex and Yearn. Such protocols distribute liquidity to specific markets more swiftly and cost-effectively than groups of distributed investors. You will be rewarded explicitly and implicitly.

Marketing

You can offer increased Total Value Locked (TVL) to some protocols and raise project awareness and usage. The protocol will reward you through their native currency.

How to Maximize Yield Farming Gains

You can maximize your yield farming gains by:

  • Leveraging yield farming tools Though yield firms can offer good returns, some require users to lock up assets for a certain period to gain the best rewards. However, with the introduction of yield farming tools such as Prophecy’s Prophet Pools, you no longer have to lock your assets in extended periods to maximize your yield farming gains.
  • Using open lending to increase exposure You can maximize your yield gains by leveraging open lending or LEGO models before committing your funds to a farm. These models let you place collateral and borrow a low-interest loan. You can use the collateral to unlock liquidity and make more investments.
  • Playing the field and buying safe As more people invest in a farm, the rewards decrease. In other words, the early bird catches the worm and receives the best yield. Once your yield starts to decline, know that it is time to look for another fertile farm.

Best Platforms for Yield Farming

As a yield farmer, you need an excellent DeFi platform to get the best out of your investment. Below are the top platforms for yield farming.

Aave

Aave is a decentralized liquidity farming protocol that allows crypto investors to lend and borrow digital assets. As an Aave lender, you will be rewarded with AAVE tokens based on the market borrowing demand. You can serve as an Aave depositor and borrower by leveraging your deposited funds as collateral.

Compound

Compound is a decentralized algorithmic protocol you can use to farm yield. It applies an autonomous interest rate smart contract to establish the rewards depositors receive from their stakes.

Curve Finance

This is one of the best liquidity pools built on the Ethereum network that employs an AMM algorithm to allow users to exchange stablecoins. Stablecoin liquidity pools are safer than crypto pools because their value is attached to an underlying asset.

Conclusion

Yield farming is an investment strategy that allows you to lend your digital assets and earn passive income. As DeFi adoption continues to gain traction, yield farming will go mainstream. Like any investment, there are risks of yield farming you should consider. Ensure you learn the ins and outs of yield farming before investing your money in any farm.

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