How To Yield Farm In Cryptocurrency?

The cryptocurrency ecosystem as we know functions majorly via two processes, mining and farming (yield farming). Both these processes bring earnings but are based on different mechanisms. We’ve already covered the mechanisms for mining and now we’ll talk about yield farming in cryptocurrency. 

The simplest hook to start a conversation about yield farming is stating that this is a passive income crypto technique that doesn’t necessitate geekiness. How about that? 

Another word for yield farming is liquidity mining and the term stems from the idea of liquidity pools where you can stake your crypto assets in order to earn rewards.

This whole earning strategy is based on decentralized finance (DeFi platforms) and takes place through smart contracts. Hence, yield farming covers much of the technical and essential basis of cryptocurrencies or DeFi for that matter. 

The crypto ecosystem, ever since its introduction has been on the fight to decentralize the financial system and free it from intermediaries, government and regulatory controls. But that dream is invalid without the stronghold of trust. Much like most things in the world, trust doesn’t come free of cost. And with that idea came the process of yield farm in cryptocurrency.

Yield Farm In Cryptocurrency And The Trust Factor 

To run a decentralized system you must entrust someone with the responsibility and reward them for the same. DeFi yield farm in cryptocurrency allows users to participate in peer-to-peer financial activities in return for putting their crypto wealth in a liquidity pool. These pools allow other crypto users to swap assets and the liquidity providers to earn rewards for putting their assets in the pool, all regulated under a smart contract. 

The next question that automatically follows is where does this nexus exist?

It lies in Decentralized Exchanges (DEXs) known as Automated Market Makers (AMM) such as Uniswap, Balancer, Sushiswap and Curve.

These platforms function with a totally non-invasive method where it bypasses the intermediary act of creating match lists for buyers and sellers. Instead, users can extract assets and trade them from the liquidity pool under smart contracts.

Thus, you can trade independently according to your time without involving a third party or their ideas. 

The Fundamental Components Of Yield Farming 

Yield farm in cryptocurrency has some basic components that are essential to its three-fold nexus of liquidity pools, liquidity providers and traders. 

1. Lending 

This is a DeFi service that functions on public blockchains like Ethereum using peer-to-peer networks and is powered by decentralized applications (DApps). With this service, you can borrow cryptocurrencies with a collateral deposit that exceeds the loan value by 1.5 to 3 times. 

2. Staking 

This is the crypto staking process that creates trustworthiness in users by rewarding them for maintaining the integrity of the blockchain. With the use of the Proof of Stake (PoS) mechanism, allows stalkers to validate transactions. The higher your stake, the more your chances to become a validator for the network and hence to earn rewards. 

3. Yield Aggregators 

These are auto investment optimizers or a non-human fund manager, decentralized platforms that use smart contracts to optimize and manage investments in DeFi. It takes up the pooled funds from different investors and applies state-of-the-art strategies to invest the same across several profitable products and services, thus, maximizing the return of investments for the lenders.

4. Governance Tokens 

Remember when we said staking your crypto in a smart contract pool (liquidity pool) gives you the power to participate in the decision-making tasks of the blockchain? Well, governance tokens are your card to do that. When you stake your crypto assets, you get these tokens as rewards that let you participate in various integral functions of the blockchain. 

How Does Yield Farming Work? 

Even though the technical jargon and the DiFi essence of the cryptocurrency world differ from centralized banking systems, when it comes to yield farms in cryptocurrency, the working cycle is quite similar to the latter. 

1. Selecting The Platform 

This function completely depends on your understanding, research and trust values when selecting a platform. As we know, DeFi platforms like Uniswap, Curve and others support yield farms in cryptocurrency and have provisions for issuing strong governance tokens as rewards. Therefore, depending on your DeFi goals you can select a platform that supports your endeavours of gaining control over a blockchain. 

2. Fill The Pool 

Different liquidity pools function on different PoS, thus making the rules variable. The liquidity deposits usually need a pair of two different cryptos, with different valuations but in equal amounts. Now the differentiating factor comes in with the asset specifications on different networks. Hence, when filling the pool, select the PoS that specifies crypto deposits of the assets you own. 

3. Get Your LP Tokens 

Once your funds go into the pool, you will receive the LP token that symbolizes your partial ownership (stake) of the pool. These LP tokens are similar to bonds. You can stake these tokens on the same or other platforms. 

4. Yielding Rewards 

In the case of staking LPs, you can yield staking rewards that add up your token amount. Therefore, when you’re functioning on these DApps, the rates of assets are often displayed as Annual Percentage Yield (APY). 

5. Take It Or Put It Back 

You have the choice to claim the rewards or reinvest the returns for compound gains. 

Risk Consideration For Yield Farming 

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1. Impermanent loss 

Putting it simply, impermanent loss is when your staked assets lose value due to market volatility and you have to withdraw it at a loss. This poses liquidity pools as a riskier tool than wallets. Liquidity pools commonly function with one fixed rule, you must deposit two different assets.

Now, when the price of one asset goes way high and the other falls crashing, the liquidity pool automatically balances the valuation where you can withdraw more of the less-valuable asset and less of the more-valuable asset in order to maintain the total valuation of the pool. 

2. Smart Contract Risks 

Smart contracts are codes at the end of the day. Hence, they do not come without risks. Smart contracts are vulnerable to malicious online activities and bugs that can lead to huge losses. One such incident was the Wormhole Token Bridge incident of 2022 or Nirvana’s exploitation for $3.49M. 

3. Rug Pulls And Scams 

These are by far the most dangerous and outright scams in the crypto world pulled off by developers and coders. They create a liquidity pool with a PoS contract and LP tokens to tempt investors.

They then drain the pool by selling off the tokens for a popular crypto which leads the LP token’s value to crash heavily and the users holding onto these tokens that have no value at all. Rug pull events are the worst outcome of the lack of regulation. 

Crypto Enthusiasm And Yield Farming 

For crypto enthusiasts, yield farming is an option that helps them find a great deal that includes security and earnings at the same time. Even though the crypto world is extremely volatile, methods like yielding provide you with some respite.

We are all tired of the fluctuations and worried to death about our losses when it comes to crypto. Nevertheless, if you could choose a strong value-based DEX platform with a good liquidity pool, you can let go of the worries.