What is Yield Farming?
What if we told you that you can earn as high as 10,000% APY interest on your asset?
In DeFi, that’s totally possible, though opportunities with 10,000 APY are highly risky and could result in losses, and we strictly advise against putting any significant sums of capital in these farms – more on this later.
Yield farming is one of the memes that was created by the DeFi community.
It often requires providing liquidity or lending liquidity in a permissionless DeFi protocol to earn passive income.
Think about this as the equivalent of a customer acquisition cost to bootstrap the project.
Imagine if Facebook rewarded early users with their own Facebook stock, which will grant early users a say in how Facebook is governed and earn from the appreciating stock value.
To put it simply, farming means getting rewards (in terms of getting more tokens) by putting your crypto assets to work by using it to provide liquidity, or lending it out.
When you deposit your money in the bank, you get a yearly interest, based on the amount of your savings.
In DeFi, when you stake your assets, you may receive interest or fees as a reward. With several protocols, especially new ones, gives you high amounts of newly generated cryptocurrencies in return, this sets a precedence for users to constantly move their capital across different projects to chase the highest yields – this is broadly known as yield farming.
The tokens that are rewarded can either shoot up in price or suffer from a catastrophic dump, depending on your entry to the farm. This is because early participants benefit the most from yield farming, and when early participants decide to cash out, it comes at the expense of those who entered later. Again, this highly depends on how each project allocates its rewards.
So imagine someone asks you to deposit Bitcoin and Ether to inject liquidity, in return they will give you thousands of little unknown coins every few seconds as a reward.
These tokens might seem worthless at the start, but if the project develops a use case for them, they can be worth a fairly significant amount of money and your original Bitcoin and Ether is safe in a smart contract that you can extract anytime you want.
Before we begin, if you’re new to cryptocurrency and want to get started, do sign up for our free HUSTLR Crypto Mail newsletter down below where we’ll walk you through the world of crypto as a total beginner and give you daily updates on all things crypto.
Things you need to know about Yield Farming
As lucrative as this might sound, you need to know exactly what you’re doing to farm profitably. Protocols are constantly experimenting new ways to maximize yield for their users – but each strategy has its own caveats that can make or break your profitability.
This can be insanely lucrative, especially if you are early to participate in the liquidity event where you own a large percentage of the pool rewards.
On the other hand, if you are farming in Pool 2 (a common name for pools of the reward token), you must realize that the tokens you are holding in your LP can crash catastrophically – as farmers in other pools are being rewarded in that token and dumping them.
These are usually the pools which have crazy APYs, but its your responsibility to manage your risk appropriately on how you approach these opportunities. Do note that these pools are extremely risky and you could lose all of your funds due to Impermanent Losses.
With that out of the way, here are some concepts you need to understand about Yield Farming.
Liquidity mining derives its name from the fact that users are incentivized to help projects bootstrap liquidity so that they can facilitate exchanges between different tokens.
If a trader wishes to convert Bitcoin to US dollars, on a centralized exchange like Coinbase, there are both buyers and sellers matched to each other.
However, for decentralized exchanges (or commonly known as DEXs), a lot of liquidity is needed to allow exchanges with acceptable rates, which is why users are incentivized to provide their capital as liquidity on these protocols.
The fundamental aspect of DeFi dapps is that liquidity comes from a decentralised liquidity pool, where anyone can swap between different cryptocurrencies in that pool.
When a user tries to swap BTC to USDT on a DEX like Uniswap, the protocol simply deposits BTC and withdraws USDT from the pool that liquidity providers have contributed to in terms of liquidity.
These Liquidity providers earn the trading fees paid by the traders swapping tokens.
For example, on Pancake Swap, one of the most popular decentralized exchanges on BSC, to provide CAKE-BNB liquidity on PancakeSwap, you add CAKE and BNB to the pool at equal value proportion, according to their rate.
Let’s say the ratio is 0.058. So for each 1 BNB you provide, you need to provide 17.2 CAKE.
You now don’t own those CAKE or BNB coins anymore. Instead, you own a proportion of the liquidity pool, tokenized in the form of CAKE-BNB LP.
Once you’ve converted your CAKE and BNB to LP tokens, you can then stake them to receive rewards, which will show up on Pancakeswap for you to claim.
For CAKE-BNB LP, the last APR is 21.3% (slightly outdated as this changes all the time).
This number goes up as there’s more transactions, and goes down as there’s more people providing liquidity (diluting your share of the pool).
You’ll receive the transactions fees in both CAKE and BNB coins when you cash out, though the incentivized rewards you will be receiving should dwarf these small gains.
When you provide pair liquidity, however, you don’t own the tokens anymore. This means you’re subject to Impermanent Loss (IL).
As the value of BNB and CAKE change due to trading, oftentimes the value proportion of the two also change.
This means when you cash out of the liquidity pool using your CAKE-BNB LP, the amount of CAKE and BNB coins you receive will be according to this new market proportion.
Any divergence, up or down, will lead to you receiving less money. A 25% difference is a 0.6% loss. A 2x will lead to a 5.7% loss. A 5x leads to 25.5% loss.
Impermanent Losses are usually just reductions on the APY from fees, but in extreme situations they can surpass the fees APY and lead to actual losses.
Impermanent Losses are a risk of providing liquidity, but liquidity providing is usually incentivized, where you would gain more in rewards than you lose with IL.
On PancakeSwap, you can farm your CAKE-BNB LP tokens to earn 57% APR, EXTRA to whatever else you may earn from the fees / loss from IL.
This APR is paid in CAKE only.
So if you provide liquidity and farm, you gain: fees APR + farm APR – IL
If you like the idea of earning passive income just by farming but don’t want to be exposed to IL, there are also single asset pools where you can basically earn rewards by leaving your assets there.
You can stake CAKE, by itself (no IL), without pairing with anything, and receive CAKE back as reward. A great place to do this is on Pancake Bunny, an automated yield aggregator.
You can harvest the CAKE yields at any moment. Additionally, you can also manually compound your earnings, where you reinvest your rewards.
When staking, you don’t gain the insane rewards that LPs/farmers do, but you’re not subject to any IL. You gain the staking APR and that’s it – this is great for those of you who hold a large amount of tokens and don’t want any risk of losing your capital.
Staking and Farming APRs are subject to change over time, and will likely go down heavily as more people stake their coins – this means that you own a smaller percentage of the pool and thus are eligible for a smaller percentage of the rewards.
Still confused on how this works?
Check out this video made by HUSTLR awhile ago on how to farm on Sushiswap, which was one of the most hyped up farms at the time. Do keep in mind that this video is outdated, and the SUSHI token has since had massive price swings – look up SUSHI on Coingecko to see what we mean here.
Anyhow, these are 2 of the most common ways that you can earn ‘farm’ on DeFi protocols, and we’ve barely scratched the surface here.
The most lucrative farms are the ones where you enter before it’s discovered by others, but these come with huge risks where you can potentially lose a ton of money.
Again, it’s important to only invest what you can afford to lose, and never let greed cloud your decision making process.
In the world of DeFi, there are a ton of new projects that are launching, new farms appearing out of nowhere, and crazy returns to be made by entering new projects early. You can be rewarded for taking on risks, but if you just want to make your Bitcoin, Ethereum or other cryptocurrencies more productive while holding on to them, yield farming is a great way to generate some income on the side while being exposed to appreciating assets.
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Bernard currently works full-time as a growth hacker and content researcher for HUSTLR. When he was studying in the US 2 years ago, he flipped Yeezys on eBay as a side hustle to fund his degree and living expenses. He’s currently working on his Amazon FBA business & dropshipping on the side.