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DeFi
3 min

What Is Yield Farming?

Published on
June 22, 2022
MonsterArmyMonsterArmyMonsterArmy

What Is Yield Farming?

During the summer of 2020, yield farming was introduced alongside governance models. A unique yield product arose as more developers concentrated on extending DEXs and boosting their level of decentralization by delegating decision-making to the community. Yield farming is similar to liquidity mining, except that farmers earn LP or governance tokens in addition to Bitcoin.

What is Yield Farming, and how does it work?

The governance model for each decentralized DeFi project is different. The use of governance tokens contributes to the model's utility. A participant who provides liquidity to a DEX with a governance mechanism earns governance tokens in addition to fees.

Instead, the protocol will distribute LP tokens, reflecting a user's liquidity pool portion. LP tokens are ERC-20 tokens stored in the contributor's wallet, allowing them to be utilized on other DeFi protocols. As a result, by farming current crypto assets and new LP tokens, one can optimize their income.

Another essential factor to keep in mind is that yield farmers in the crypto market are aggressive. They are compelled to constantly chase liquidity pools with the highest APY rate to earn the best returns and stay competitive.

This frantic activity spawned yield farming aggregators, protocols that enable farmers to participate in the best LPs from a single location. Yearn Finance, the popular DEX established by well-known DeFi developer Andre Cronje, is an excellent example of a yield farming aggregator.

Yield farmers, like liquidity miners, suffer temporary losses; the difference is that the risk is much more significant if farmers elect to farm LP tokens as well.

Yield Farming: A Step-by-Step Guide

A step-by-step approach is an excellent way to grasp yield farming and its rising complexity. We've used MetaMask as an example, so check out our How to Use MetaMask tutorial if you need more information. Here are the eleven stages you must follow to farm:

  1. Purchase BTC, ETH, USDT, USDC, or DAI with BTC, ETH, USDT, USDC, or DAI. For most DeFi systems, these are the most widely accepted coins for producing yield. Regardless of what you use as gas, you'll need to buy some ETH, which we'll explain later.
  2. You can download the MetaMask Wallet browser extension here. After installation, create a wallet and make a secure backup of your keys and seed phrase.
  3. ERC-20 tokens — tokens created on the Ethereum blockchain — are stored in MetaMask wallets. Most DeFi platforms, it just so happens, are also built on Ethereum. Except for Bitcoin, you should have no trouble transmitting the currencies from step one to your MetaMask. If you wish to utilize Bitcoin on the Ethereum blockchain and keep it in your MetaMask, you'll need to wrap it with the Ren Bridge or buy wBTC on an exchange first.
  4. You're ready to interact with DeFi platforms and begin the never-ending pleasure of yield farming once your ERC-20 tokens are safely stored in your MetaMask wallet.
  5. We advocate learning yield farming with Compound Finance for the sake of simplicity. The Compound is the DeFi platform that started the yield farming frenzy and is, in many respects, the most beginner-friendly. Go to Compound and click the App button in the upper right corner.
  6. You'll be prompted to connect your wallet after clicking App. Then sign in to your MetaMask account by selecting the MetaMask option.
  7. On the Supply side of the landing page, choose the asset you want to supply. Select the amount you'd like to donate, then click the donate button. It's worth noting that there are two APY metrics displayed: supply and distribution. The former is compensated in kind (the same as the deposited asset), whereas the latter is paid in cash. This means you're getting two different types of APY for the same deposit.
  8. You will be asked to confirm two transactions via MetaMask. The initial step is to communicate with the Compound smart contract then confirm the transaction. Both will require gas, so you should have ETH in your wallet regardless of the supply asset you choose.
  9. The Compound app will alert you that everything is fine after the transactions are confirmed, and your balance column will populate with the amount you provided. TO THE LEFT OF THE BALANCE, the APY / Made column shows your APY rate and how much you've earned.
  10. A Net APY gauge is located at the top of the Compound page to assist you in keeping track of your overall APY received from both supply and distribution APY rates.
  11. You can now borrow against your supplied assets to generate even more distribution APY (paid in COMP) while lending those assets back to Compound or another DeFi platform like Aave, Yearn Finance, or Curve Finance to boost your yield farm potential.

Conclusion

Yield farming and liquidity mining are nearly the same. However, a few essential distinctions could make choosing between the two difficult. To sum it up:

  • Farming for yield is a competitive business.
  • Farming with a higher yield yields better rewards.
  • Yield farming protocols also give LP tokens or governance tokens in addition to fee incentives.
  • IL risk rates rise when LP tokens are farmed.
  • We recommend the following yield farming protocols based on their difficulty.
  • Invest in Solid Project like MonsterArmy