How Does Crypto Yield Farming Work?
Simply put, crypto yield farming is the process of providing crypto assets assets to earn income on Decentralized Finance (DeFi) platforms. An investor can increase their profits by making their coins available to other investors. They do this by investing assets in a liquidity pool for for Swap trades or for loans, or a pool for allowing them to take interest-accumulating loans on the coins provided by the original investor.
Another way investors can earn passive income is by staking crypto tokens as a liquidity provider. Staking crypto allow users to pool their crypto into a smart contract that automatically triggers a staking pool. Staking typically only require users to spend one lone asset in exchange for the opportunity to earn passive income as opposed to serving as an LP. This facet makes for a slightly easier yield farming experience.
The investor who makes their coins available for DeFi market making is known as a liquidity provider. The liquidity provider provides funds using a smart contract known as a liquidity pool.
Yield farming relies on the automated market maker (AMM) in order to function, eliminating the need for a traditional order book that contains the “buy” and “sell” orders present on cryptocurrency exchanges.
AMM liquidity pools are capable of executing trades based on algorithms that are predetermined which eliminates the need to state the price a coin is set to begin trading at.
Crypto Yield Farming Explained
Yield farming crypto is essentially the practice of either loaning cryptocurrency to other investors with the goal of earning interest, or providing liquidty and earning fees on DeFI trading transactions. For more details about the specifics of yield farming crypto, keep reading.
Where Can You Yield Farm Crypto?
Over the course of the past few years as yield farming has grown more popular among investors, there’s been an influx of platforms where people can take part in yield farming crypto, like Compound, Uniswap, YeFi, and Apnify’s new exchange, HEX.
How Do You Calculate Yield Farming Returns?
Yield farming crypto returns are typically expressed as annual percentage yields since they’re calculated on an annual basis. Even though there’s no exact method to calculate how much APY an investor will receive from yield farming, there is a good rule of thumb to keep in mind.
That is, if investors elect to receive their payout by receiving a particular DeFi token, that token could drop in value relative to other currencies which could lead to gains being reduced or eliminated entirely.
Can You Lose Money Yield Farming?
There are multiple ways that investors can lose money in yield farming when providing liquidity. Yield farming crypto can result in losing money due to exploits, and due to the fact that in most cases investors choose to receive their payouts in coins that could quickly lose value.
Given the steep variations in the crypto market from day to day, crypto investors who engage in yield farming are exposed to the risk of impermanent loss. When investors receive their payouts in coins that erode in value, they essentially leave the transaction without any gains.
Example of Yield Farming
A farmer yield farming crypto by providing a liquidity pool with capital could provide tokens to a liquidity pool that exists in a protocol like LoFi or Uniswap, then get rewarded for it by receiving the fees that are charged for exchanging tokens.
Another example of yield farming crypto could entail an investor earning APY on their capital by supplying tokens on a lending platform like Compound. Investors would benefit from that by receiving extra tokens from the platform in return for lending on their platform.
Advantages of Crypto Yield Farming
The benefits that come with yield farming crypto are clear. They include:
- Higher Interest than Traditional Banks: Investors are more likely to receive higher APY from crypto yield farming than from opening a savings account and collecting interest from a bank annually.
- Passive Income: The income that’s earned from yield farming crypto is earned effortlessly. That means it can act as a passive income once the initial investment is made, earning investors funds while they either work full-time or make other lucrative investments.
- Profitability: Yield farming crypto is an opportunity for earning money at little to no overhead or associated costs which makes it easier to reach profitability than other types of investments.
- Earn Income in Cryptocurrency: Yield farming crypto could be the ideal way for people interested, but skeptical, to make their foray into the world of cryptocurrency by earning income.
- Trustless: No banks or intermediaries are required.
Disadvantages of Crypto Yield Farming
Of course, not everything is perfect, so there are downsides that come with yield farming crypto. Those include:
- Impermanent Loss Risk: When the market makes steep fluctuations, it can result in a loss of funds. The best way to avoid impermanent risk loss is to use liquidity pools that provide solutions that circumvent impermanent risk loss.
- Liquidation Issues: When users don’t have enough capital to cover the cost of their loan, they can be subject to hefty liquidation penalties. This usually happens when people use assets that are higher in volatility.
- Smart Contract Risks: Smart contracts that aren’t well-tested for safety and security are huge security risks for everyone involved. Without a robust, well-protected smart contract, investors could be subject to cyber-attacks.
- Regulatory Risk: Since crypto yield farming is still a relatively new concept, the risk for regulation is considerably high. If governing bodies place stipulations on crypto yield farming, the earning potential of investors could be influenced heavily.
- Volatility: Just because a certain token happens to be performing well at one point, it’s no guarantee that performance will continue to follow the same pattern due to the high level of volatility present within the cryptocurrency market. Investors that don’t factor in volatility could be subject to significant losses.
Yield Farming vs Staking
Yield farming and staking have striking similarities. Understanding the differences between the two is essential for crypto investors hoping to earn passive income doing either one.
One of the main differences between yield farming and staking that crypto investors should remember is that yield farming doesn’t come with the rigid requirements of some staking agreements.
Some blockchain networks make it mandatory for their users to stake funds for a fixed period of time, while yield farming doesn’t have the same requirements. Another big difference between the two is that staking doesn’t expose crypto investors to the same level of risk for impermanent loss.
Institutional Yield Farming with HEX
Crypto yield farming could provide investors with the passive revenue stream they’ve been waiting for. Although there are risks involved, the potential for reward is great, and getting involved is simple.
That’s especially the case when institutional investors choose yield farming with HEX. HEX offers lower fees, along with decentralized exchanges. To find out why institutional yield farming with HEX is ideal for cryptocurrency investors seeking to maximize their profits, join the VIP program today.