Updated: Jan 2
In this 5th article of our multi-part getting started series we take a look at yield farming. This time we get help from Whiteboard Crypto, a great educational source for anyone getting started in crypto/blockchain/DeFi.
In traditional finance, yield is referenced in relation to dividends that companies pay their shareholders (or distributions if wer'e in ETF world). These are incentives to investors to hold their shares and the same can be seen in the world of crypto with various protocols providing forms of yield for investors who hold their tokens. Yield farming is something that is commonly referred to in this space and below we explore this topic.
What is yield farming?
One of the hot topics in the space of DeFi and crypto is the area of yield farming which is essentially the different ways that money can be earned on being invested in this space. Yield farming is essentially the different ways investors choose to put their money to work and yes, there are different methods of doing this.
The following video from Whiteboard Crypto (one of the best crypto/DeFi educators online), we take a look at these different methods. Hopefully, you can gain some insight from this video and our run through of what he's explained below that.
Yield Farming Options
There are a number of ways to yield farm which include the following:
1. Liquidity Providers
This first example sees you lending out your tokens of say $500 Ethereum and $500 Attention token into a liquidity pool on UniSwap. If there was $100k there then you own 1% of this. If $1 million is traded back and forth between UniSwap and Ethereum and the fee is 0.3%, of the $30k earned that day in interest, you would get $30 for that day.
2. Borrowing and Lending
Some services like Compound and Aave give rewards for lending on their app with some coins gettin upwards of 30% APR on the app.
In the case of borrowing, this allows you to lend your coins as collateral (as you don't want to cash this out just yet) and swap for another token like DAI. The uinque thing here is that these loans are always over-collateralised so you always have to provide more tokens than what you have. This is okay if you have Ethereum and think it's going to go up. You borrow your DAI and when you eventually pay that back to get your original Ethereum, hopefully Ethereum has gone up. This is like a second mortgage on a house.
There is also Leveraged Lending which is basically lending on margin, hence it is risky. In this example you take what you can lend and borrow and continue to put that to work or borrow what you can get and convert back and lend it out and keep repeating this process. For example, if you deposit Attention token on Aave of $100 to get back $60 DAI and then resupply that back to Aave to get $36 DAI and repeat the process. You can end up earning 30% APR on $200 of assets. Another risk here is that if Attention token price falls you can get liquidated to cover the lenders funds.
Another form of yield farming. In this case is that you would buy coins, stake them to earn more free coins. An example of this is Tezos which has a 6% APR but need a staking node that will be reliable throughout the year. Another option is to do via Coinbase which takes a fee for doing this.
When Ethereum moves to its 2.0 version, this is also another way to potentially earn rewards. When the current Proof of Work model goes to Proof of Stake, instead of a bunch of miners doing work to mine Ethereum, it will be 1 miner at a time to validate the blocks and get rewarded and again this can be done for a fee on platforms like Coinbase if you don't want to set up your own staking node.
Finally, there is staking LP tokens. These are tokens you get for providing liquidity to a platform. You get ETH, BAT, UniSwap tokens. These platforms allow you to stake these tokens to earn more interest so you do not remove liquidity. The risk here is that these are deflationary. Many don’t go for a liquidity pool token as this could go to zero as they produce more and more.
4. Holdings coins with distribution fees
Another is to hold tokens that have redistribution fee. E.g. Safemoon has a 10% transaction fee where half of this is redistributed to all token holders and other half is burnt. Deflationary risks as well
The video then looks at other risks that come with yield farming such as Impermanent loss Rug Pulls. Whilst not mentioned in the video, we highlight for investors to look at the work being done by Rugdoc (www.rugdoc.io) that reviews various tokens to highlight any that are showing signs of being at risk of a rug pull.
It's important for new investors to do their homework with new types of investing like this, especially as the space is new and being figured out. The great thing we find with all of this is how open and transparent the hindustry is as a whole where learning is not restricted and is available to those who want to put in the time to do so.
If you've come this far you should check out the other videos in our series as well as those which are coming up.
The Full Series
Part 4 - What is DeFi? - This video
Part 7 - Risks and Impermanent Loss
Part 8 - Tools and data to analyse tokens/cryptos
Part 9 - How to avoid scams?
Part 10 - Protocol types
Part 11 - What's on the horizon - the metaverse, DeFi 2.0
Part 12 - What is a DAO?