To put it in simple words, 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 decentralised finance (DeFi) has exploded in popularity recently.
Yield farming techniques, in brief, encourage liquidity providers (LPs) to stake or lock up their crypto assets in a smart contract-based liquidity pool. A share of transaction fees, interest from lenders, or a governance token can all be used as incentives (see liquidity mining below). These results are expressed as a percentage yield on a yearly basis (APY). The value of the issued returns decreases as more investors add funds to the relevant liquidity pool.

BENEFITS OF YIELD FARMING

-Decentralized financial yield farming ensures that it is open to all, that all actions are transparent, and that it is not dependent on the beliefs of the parties involved.

-Due to its widespread popularity and utility, numerous applications and exchanges will allow you to participate in the process of yield farming

-Getting started with yield farming is a breeze. You only need cryptocurrencies and a cryptocurrency wallet to participate.

HOW DOES YIELD FARMING WORK

Liquidity providers are users who contribute their bitcoins to the DeFi platform’s operation (LPs). These LPs contribute coins or tokens to a liquidity pool, which is a decentralised application (dApp) built on smart contracts that hold all of the funds. When LPs place tokens in a liquidity fund, they are paid a fee or interest based on the underlying DeFi platform that the liquidity pool is running on.

Simply said, it’s a way for you to earn money by lending your tokens through a decentralised application (dApp). There is no middleman or intermediary in the financing process because smart contracts are used.

A marketplace where anyone can lend or borrow tokens is powered by the liquidity pool. Users must pay fees to access these marketplaces, which are used to compensate liquidity providers for staking their tokens in the pool. The Ethereum platform is where the majority of yield farming takes happening. As a result, the payouts are an ERC-20 token. While lenders can spend the tokens however they like, the majority of them are currently speculators looking for arbitrage possibilities by profiting from the token’s market swings.

IS YIELD FARMING POPULAR

The creation of the COMP token, a Compound Finance ecosystem governance token, is credited with the rise in the practice of yield farming. Holders of governance tokens can participate in the governance of a DeFi protocol. To create a decentralised blockchain, governance tokens will frequently be allocated algorithmically with liquidity incentives. This incentivizes future yield producers to contribute liquidity to a pool.