Staking or lending crypto assets to create high returns or rewards in the form of additional cryptocurrency is known as yield farming. Thanks to breakthroughs like liquidity mining, this inventive yet dangerous and unpredictable application of decentralized finance (Defi) has exploded in popularity recently. Yield farming is currently the most important development driver in the still-developing Defi sector, helping it to grow from $500 million in market capitalization to $10 billion by 2020.
Yield farming techniques, in brief, encourage liquidity providers (LPs) to stake or lock up their crypto assets in a smart contract-based liquidity pool. These incentives could be based on a proportion of the transaction value. These returns are expressed as an annual percentage yield (APY). As more investors add funds to the related liquidity pool, the value of the issued returns decrease accordingly.
What Are The Protocols Of Yield Farming:
Aave: It is a non-custodial open-source decentralized lending and borrowing protocol that allows users to borrow assets and receive compound interest for lending in the form of the AAVE (formerly LEND) token. As of August 2021, Aave has the highest TVL locked out of all Defi protocols, at about $21 billion. On AAVE, users can earn up to 15% APR for lending.
Instadapp: It is the world’s most advanced platform for maximizing DeFi’s potential. Users may manage and expand their Defi portfolios, while developers can use their platform to create Defi infrastructure. Instadapp has a total value of $9.4 billion as of August 2021.
SushiSwap: It is a fork of Uniswap that sparked a massive uproar in the community during their liquidity move. With multi-chain AMM, loan and leverage markets, onchain mini Dapps, and a launchpad, it’s now a Defi ecosystem. As of August 2021, TVL on the platform is worth $3.55 billion.
Balancer: It is a trading platform and automated portfolio manager. Its liquidity methodology is unique in that it allows for flexible staking. Lenders don’t need to supply liquidity to both pools in an identical amount. Liquidity providers can instead construct unique liquidity pools with different token ratios. As of August 2021, about $1.8 billion has been committed.
Yearn. finance: It is a decentralized automated aggregation protocol that allows yield producers to use different loan protocols such as Aave and Compound to get the best yield. Yearn. finance employs rebasing to maximize profit by algorithmically locating the most profitable yield farming services.
What Are The Risk In Yield Farming?
Risk of impermanent loss
Liquidity providers must contribute cash to pools to receive yields and trading fees from decentralized exchanges (DEXs). This provides LPs with market-neutral returns, although it may be dangerous during market downturns.
This danger exists because AMMs do not adjust token prices by market fluctuations. For example, if the price of an asset lowers by 60% on a centralized exchange, the change will not be immediately reflected on a DEX.
Risks associated with smart contracts
Smart contracts are paperless digital codes that contain predetermined rules and self-execute the agreement between parties. Smart contracts eliminate the need for middlemen, making transactions cheaper and safer. They are, nevertheless, vulnerable to attack vectors and coding flaws. Smart contract frauds have affected users of the popular Defi protocols Uniswap and Acropolis.
Risks of liquidation
Defi platforms, like traditional finance, leverage their customers’ deposits to create liquidity to their markets. However, if the value of the collateral falls below the loan’s price, a problem may occur. If you take out an ETH loan using BTC as collateral, for example, if the price of ETH rises, the loan will be liquidated since the value of the collateral (BTC) is less than the value of the ETH loan.
This is a costly and time-consuming process.
Farming for yield is a capital-intensive business. The majority of the cost concerns are around the Ethereum network’s gas prices. Josh Rager, the creator of cryptocurrency trading service Blockroots.com, complained on Twitter last August that he had to pay up to US$1,200 in fees to buy tokens on a Defi project. This is a bigger problem for smaller participants than for affluent people who have more money. Due to high petrol costs, smaller participants may find that they are unable to withdraw their money.