What Is Yield Farming?

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It’s no secret that putting money in a traditional savings account is a losing proposition. The national average interest rate for savings accounts is 0.06 percent, according to Bankrate’s survey from April 6, 2022. When you compare that rate to what it charges for a loan, it’s laughable. The days of depositing money into a savings account and watching it grow appear to be over.

As a result, to keep up with inflation, many people are driven into riskier investments. It’s a fact that all investments involve some level of risk. As an asset class, cryptocurrencies are on the riskier side. On the other hand, cryptocurrencies can play an essential part in an investment portfolio if approached carefully.

Crypto staking for interest has been around for years and can earn excellent yields. Price volatility is a significant risk, but much of that risk can be mitigated by staking stablecoins. This article concentrates on a newer strategy for capturing yield called yield farming. 

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What is Yield Farming?

Yield farming is a way to generate rewards with crypto that you hold. When yield farming, you provide liquidity by depositing your crypto into liquidity pools. If you don’t know, a liquidity pool is a smart contract containing funds used for trading. For providing this liquidity, you receive crypto as a reward.

In more detail, the process entails liquidity providers (LPs) depositing cryptocurrency into a liquidity pool. The liquidity pool powers decentralized exchanges (DEXs) that let investors trade crypto in a peer-to-peer manner. Users of the DEX pay fees that are distributed to liquidity providers. Each provider’s fee share is proportional to its share of the liquidity pool.

Forms of yield farming include:

Liquidity provision (LP’ing): Users deposit two paired coins or tokens (50/50 ratio) into liquidity pools. The liquidity pools supply trading liquidity to DEXs like Uniswap, SushiSwap, and Quickswap. The DEX charges users transaction fees which are paid out to the liquidity providers. 

Lending: Coin and token holders can lend out their crypto to borrowers through a smart contract and earn yield from the interest paid on the loan.

Borrowing: Yield farmers can use one coin or token as collateral to borrow another coin or token. They can then use the borrowed coin or token to farm yield. 

Staking: Staking is a popular way to earn passive income on crypto. It’s similar to depositing money into a high-yield savings account. When you stake digital assets, you lock up a native cryptocurrency to participate in validating transactions and provide security to the blockchain. In exchange for participating, you receive payments denominated in the native cryptocurrency. 

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Where to Yield Farm Crypto

If what you have read so far has you interested in yield farming, where do you start? There’s no shortage of DeFi platforms, which is good. Many yield farmers employ various yield farming strategies on multiple platforms. Some platforms will be better for lending, borrowing or staking, and others may have better liquidity pools. 

Here is a list of some of the most popular platforms and what they offer.

• Aave: Aave is a decentralized lending and borrowing protocol. Users can earn compound interest for lending in the form of the Aave token as well as other ERC-20 tokens. Aave is a non-custodial and open-source platform built on Ethereum. 

• Balancer: Balancer is an automated portfolio manager and trading platform. Its liquidity protocol is unique in that it allows for flexible staking. A major benefit of Balancer is that it doesn’t require lenders to add liquidity to both pools equally. Liquidity providers can create customized liquidity pools with varying ratios. 

• Compound: Compound is a protocol on the Ethereum blockchain that establishes money markets. The money markets are pools of assets with algorithmically derived interest rates. The interest rates are based on the supply and demand of the asset. Lenders and borrowers interact directly with the protocol and earn or pay a floating interest rate. 

• Hodlnaut: Hodlnaut is a crypto interest-bearing platform that offers compound interest of almost 14%. Hodlnaut supports eight different cryptocurrencies, Bitcoin, WBTC, Ethereum, DAI, LUNA, USDC, USDT and UST. The interest paid varies depending on the amount deposited. 

• Gemini: Gemini allows you to stake almost 50 different cryptocurrencies. It requires no minimums, and you can transfer back into your trading account whenever you want. You can earn up to 8% on cryptocurrencies you already hold. 

Yield Farming Risks

When done correctly, yield farming can be highly profitable. However, that doesn’t mean that it doesn’t carry risks. Cryptocurrencies can be very volatile, and the risk of impermanent loss is real. Impermanent loss occurs when you supply liquidity to a liquidity pool, then the price of your deposited crypto drops.

A falling interest rate is another risk to be aware of. The yield will fall as more people join liquidity pools and liquidity increases. It is critical to monitor the yield and keep an eye out for other higher-yielding pools into which you can rotate. Typically, the highest yield is paid immediately following the launch of a new pool. You can maintain a high yield by switching from one pool to another. This is easier to do on Solana, Avalanche and Layer 2 blockchains, however, because Ethereum network fees will be incurred if you use its network.

The final risk detailed in this article is smart contract risk. Smart contracts are programmable, self-executing contracts that are deployed on blockchains. Smart contracts have elevated the functionality of blockchains. They have also unlocked new opportunities to expand blockchain technology to even conservative industries. 

But, despite all of the innovation, smart contracts can have vulnerabilities that hackers can exploit. So far in 2022 alone, more than $500 million worth of tokens were stolen from the DeFi sector. Hacks of smart contracts accounted for 50% of those security incidents. 

How to Choose a Good Yield Farm

Choosing the yield farm that is right for you is a crucial first step. Just choosing based on the yield or interest rate alone may prove to be a losing strategy. Ideally, you will want to consider multiple aspects of the farm to determine if it is right for you. 

You should also review which cryptocurrencies are being farmed. If the farmed cryptocurrencies are unpopular and performing poorly, receiving them won’t be much of a reward. Also, you will want to put significant weight on the size and popularity (liquidity) of the pool. Another important consideration is the security of the platform. After all, you will be entrusting your crypto to that yield farm platform. 

Ideally, you would want to farm a cryptocurrency that you want to own. You could also farm crypto that you don’t care to hold but is performing well. Using this strategy, you could sell off your rewards as you receive them. You would then have the option to use those proceeds to either increase the size of your farm or expand into another farm. 

CoinMarketCap is a good resource for information that will help choose a good yield farm.

How to Yield Farm

One of the easiest platforms to earn interest on cryptocurrencies is Hodlnaut. Hodlnaut is an excellent platform for anyone new to cryptocurrencies. As a centralized exchange (CEX), you have to open an account and complete the Know Your Customer (KYC) process before using the platform. 

• Go to Hodlnaut, open an account and supply the requested information to complete the KYC process.
• After your account is approved, deposit crypto.
• Similar to a traditional savings account, you earn interest.
• You also choose how your interest is paid to your account. You can choose from eight different cryptocurrencies. 

Another option is to use a DEX. This option would be better for someone with more experience with cryptocurrencies, as the process is more complicated. This example will use PancakeSwap and the Binance smart chain wallet. It will also assume that there is already BNB and BUSD in the wallet.

• Go to PancakeSwap.
• Connect your Binance wallet.
• Near the top of the screen, click on Liquidity.
• Click on Add Liquidity.
• Enter an equal dollar amount for each token.
• If asked, click on Enable BUSD, then click on Confirm when your wallet pops up.
• Click on Supply and click on Confirm when your wallet pops up.
• Next, go to Earn, then Farms near the upper left of the screen.
• Open the BUSD-BNB farm.
• Click on Stake LP.
• In the pop-up window, click on Max, and Confirm, then click on Confirm when your wallet pops up.
• You should now see the amount of the BUSD-BNB LP token that you have staked.

How to Store Cryptocurrency Safely

The number one responsibility of every crypto investor is to protect their digital assets. Storing large amounts of crypto on exchanges is never a good idea. If you want the ultimate protection, you will want to use a hardware (cold storage) wallet. 

One of the best hardware wallets on the market is the Ledger wallet. Hardware wallets are classified as cold storage because of the ability to isolate them from the internet. The only time the wallet is connected to the internet is when you manage your assets. 

For added security, Ledger uses the Secure Element chip, which is also used in credit cards and passports. This combination makes the Ledger more secure. 

Is Yield Farming Crypto Worth it?

Yield farming with a good strategy can be lucrative. But there is a caveat. It is essential to pay attention to the overall condition of the crypto market. No matter how much yield you are receiving, if crypto prices are plummeting, you will be in a losing position. 

During a bear market, it would be safer to yield farm stablecoins where price volatility is not an issue. Then rotate into other higher-yielding cryptos during a bull market. Yield farming can be an excellent way to generate a passive income, but you need to employ a strategy that evolves with the markets.

The post What Is Yield Farming? by Donald Hancock appeared first on Benzinga. Visit Benzinga to get more great content like this.