What Is Yield Farming?

Yield farming is a term used for describing the returns in the “rewarding scheme” that generates rewards for locking up funds through DeFi platforms. To grasp the basic concept, think of it being similar to the interest you earn when you lend out money. In DeFi though, the “rewards” are given in a more complex way, and can also be far greater than earning passive interest in traditional savings accounts. 

The process of yield farming is part of the lending (and borrowing) features in DeFi, as locking up funds and lending them out means you can earn fixed or variable interest via DeFi protocols. It can be the difference between successful user capital and beginner loss, which also highlights the importance of the risks that can be involved. 

What might be the initial appeal for people new to cryptocurrency investment is its potential gain for profit. Now innocently it is easy to fixate on the market prices and fluctuations for reassuring how much money you might be “making” as a user, but in DeFi there are more layers you can use within an investment than found in stock and bonds for example. 

How does yield farming work? 

Because of DeFi’s decentralised nature, yield farming revolves around smart contracts, liquidity providers and liquidity pools. 

Liquidity providers (a market broker or institution) deposit and lock funds into a smart contract that creates a liquidity pool. Deposited funds can be for example stablecoins linked to USD, such as DAI. These are pools of tokens that fuel the crypto marketplace by allowing efficient asset trading, and for investors to earn rewards on their holdings. Liquidity providers are rewarded with fees (or tokens) for their services, generated from the trade in that pool. 

Yield farming works specifically through lending out your tokens on a DeFi, non-custodial market protocol like Aave and receiving rewards. It cannot be achieved by solely investing in a cryptocurrency. Yield farmers are those who actively seek the highest yield on their asset funds between different liquidity pools. Rotating between pools is very common as it can maximise their returns. 

Image from  Relite Finance 

Yield farming vs staking

Yield farming is more exclusively seen providing liquidity to a DeFi protocol. And while staking does involve locking up crypto funds it also requires users to commit their assets to support the whole blockchain network involved.  

In short:

  • Yield farming - means providing liquidity to a DeFi protocol in return for reward (or yield) 
  • Staking - involves the “Proof of stake” concept where a user aids the validation of blocks in the network according to the amount of tokens they hold

What could be the risks? 

There are a few risks associated with the market around yield farming. Generally speaking it is the responsibility of the user to assess the risks involved in the investment. However there is no necessity to take unnecessary risks in order to make a worthwhile yield. 

Yield farmers are often exposed to the risks of market spikes which can result in loss. In some cases selling assets might have been more profitable than a long term investment in a market decline. Yet this hasn’t yet turned faces away from the benefits of locking funds in DeFi platforms. 

There is always a possibility that on leveraging a protocol, a user can over collateralize a loan which would then get liquidised. Yet careful monitoring and assessment can prevent this. 

What are the benefits? 

Using yield farming in the DeFi world has grown immensely since 2015 as it offers a great strategy for earning interest on investments across different risk factor environments. For farmers it is like trying to find a savings account with the best interest rates and annual percentage yield (APY). For many, yield farming consists of maximising a rate of return by leveraging different DeFi protocols - essentially, that is finding the best rewards across liquidity pools. 

Although the last 10 years may have shown just investing in cryptocurrencies to be an exponential profit success, the DeFi space has longer term functions in place like the possibility of yield farming, which may give users higher yield and activity in the marketplace, and also generate a passive income. 

How does Oasis.app fit in this picture?

Oasis.app serves as entry point to the Maker Protocol, allowing users to borrow Dai and also make leverage-like trading on their assets, but it can also fit in a Yield Farming strategy.

Users can create Dai on Oasis.app and then use these Dai in another DeFi platform, like Compound, to deposit and earn. If the yield income is greater than the stability fee paid on Oasis.app, the user doesn’t risk much - as long as they keep their vault within safe limits.

Basically, by using oasis.app first, users can potentially gain twice:

  • Keeping exposure on their ETH (or other collaterals)
  • Depositing Dai in a pool and getting interest

You can learn more and start using Oasis.app now, by checking our Knowledge Base.

3 November 2021

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