Yield farming is the process of earning a return on your capital by putting it to productive use. Money markets can offer a simple way to earn reliable yields on your crypto that you might want to use, and liquidity pools offer better yields than money markets. This being the case, they do have additional risk associated with them.
Before we dive deeper, let’s take a look back at what yield farming actually is.
Yield Farming Explained
You might have been hearing a lot lately about yield farming, and this allows people to earn fixed or variable interest through investing crypto in a DeFi market. Investing in ETH is not yield farming, and lending out ETH for a return beyond the ETH price appreciation can be yield farming. The newest trend in crypto is yield farming, and investors need to understand what it is, as well as how it works in order to get the most out of it.
Keep in mind that yield farming is only profitable if you already have a significant amount of money, to begin with.
Yield Farming, at its core, is a process that allows cryptocurrency holders to lock up their holdings, and this, in turn, gives them rewards. It is a process that lets you earn either fixed or variable interest through investing crypto in a DeFi market.
When the loans are made through banks with fiat money, the amount lent is paid back with an interest. With yield farming, the concept is quite similar, where cryptocurrency that would otherwise be sitting in an exchange or a personal wallet, is lent out through DeFi protocols in order to get a return. Keep in mind that it can also be locked into smart contracts.
Farming DeFi Yields
The first step in yield farming involves adding funds to a liquidity pool, which are essentially smart contracts that contain funds. These pools then power a marketplace where users have the ability to exchange, borrow or even lend tokens. Once you have added your funds into a pool, you have officially become a liquidity provider (LP). In return for locking up your funds in the pool, you are rewarded with fees generated from the underlying DeFi Platform.
When it comes to DeFi’s primary lending and borrowing protocols, these are Aave and Compound. That being said, lending capital on a money market is one of the easiest ways to earn a return in DeFi, and you can deposit a stablecoin to either of the two and start earning returns immediately.
Aave has a reputation for offering slightly better rates than Compound, and the primary reason for this is due to the fact that it offers borrowers the choice of a stable rate of interest and not just a variable one. The stable rate will be higher for borrowers than the variable rate, and as such, this increases the marginal return to the lenders.
Compound introduced a new incentive for users through the issuance of its native token COMP. Anyone that lends or borrows on Compound can earn a certain amount of COMP, and 2.880 COMP can be issued to the users on a daily basis. For example, as of the time of writing, 1x COMP is worth $444.69.
The main reason investors love DeFi money markets is due to the fact that they employ over-collateralization, which essentially means that the borrower has to deposit assets with more value than their loan. When the collateralization ratio or value of the collateral falls below a threshold, the collateral is liquidated and then repaid to the lenders.
Yield Farming Liquidity Pools
Uniswap and Balancer are among the world’s largest liquidity pools in DeFi that offer liquidity providers or LPs with fees as a reward for adding their assets to a pool. Liquidity pools are then configured between two assets in a 50-50 ratio in Uniswap.
Now, here’s how all of this works. Every time someone takes a trade through the liquidity pool, LPs that have contributed to that pool can earn a fee for helping facilitate it.
Uniswap pools have offered LPs large returns throughout the year as DEX volumes have picked up. However optimizing profits in yield farming does require investors to consider impermanent loss, which is the loss that is incurred by rapid appreciation or depreciation of the assets for which you are providing liquidity. Balancer pools can mitigate some impermanent loss, as pools do not need to be configured in a 50-50 allocation, and users also have the ability to learn Balancer’s Governance token known as BAL through providing liquidity.
Liquidity providers deposit funds into a liquidity pool. Deposited funds are normally stablecoins that are linked to USD, such as DAI, USDT, or USDC, but they can be cryptocurrencies as well.
Another incentive to add funds to a pool is to accumulate a token that is not on the open market or has low volume, through providing liquidity to a pool that rewards it.
Your returns are then based on the amount you invest, and the rules that the protocol itself might have. You can also create complex chains of investment through reinvesting your reward tokens into other liquidity pools, that in turn provide different reward tokens.
Drixx Earn is an integrated crypto finance provider that helps its clients access liquidity, earn yield, and manage risk across centralized and decentralized platforms with a few clicks through its user friendly interface.
Drixx takes advantage of untapped opportunities in the derivatives markets and utilizes advanced yielding techniques that enable it to deliver an average APY of up to 18.6%.
Optimized for the long-term value through delivering investment flexibility and maximizing returns, here are several highlight of the powerful Drixx platform:
- Up to 18.6% interest
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