Cryptocurrencies’ rapid growth and popularity have ignited dozens of opportunities and different alternatives to profit from them. And since people prefer to hold cryptos for long-term profit and avoid short-term volatility, yield farming opens up other options to earn money.
But what exactly is yield farming? Let’s break it down. By definition, “yield” refers to the profit earned through interest by investing. On the other hand, “farming” is the process of leveraging the resources you have. So if we apply that to cryptos, it simply means rather than letting your tokens sit somewhere in your digital storage, you could earn interest by investing or locking them up.
Top Yield Farming Platforms
Some liquidity pools have high interest returns just to attract other investors. You could be putting your funds on some liquidity pool meant to pull the rug out from all its investors. So finding a reliable platform to farm is crucial, and you should stick with trusted and well-established ones to avoid getting scammed. That being said, below are the most recommended platforms.
Different Ways to Profit from Yield Farming
As a yield farmer, there are multiple methods that you can apply to earn profits. More complex strategies also have additional rewards; however, please be aware the risk you take will also increase. Below are the most common methods to profit from yield farming.
Become a Liquidity Provider
To become a liquidity provider, you’ll need to find a safe and reliable liquidity pool with decent interest rates. After that, you’ll need to purchase tokens that you can supply to its liquidity pool.
People making trades will have to pay fees to complete their transactions. Those fees are then equally distributed to all investors that own a portion of the liquidity pool. So by becoming a liquidity provider, you are entitled to have a portion of the interest. And the amount you’ll receive is directly proportional to the amount you’ve put into it.
Staking means locking up or pledging your cryptos into the blockchain that uses a proof of stake (PoS) consensus algorithm, helping the blockchain validate transactions. And in return, you earn extra profit from interest.
Borrowing and Lending
As you already know, lending funds into the liquidity pool rewards your interest. But did you know that you can also borrow funds from the same liquidity pool you’re invested in? By leaving your funds inside the pool as collateral, you can borrow a portion of it and invest it back into the same pool for extra profit.
Picture out that you’re holding $10,000 worth of cryptos and decide to put it into the liquidity pool. You can leverage that by borrowing from the same liquidity pool. Still, it has to be overcollateralized, meaning you are entitled only to borrow less than the amount you’ve put into it. This reduces risk to the lender and assures them that you’re not going anywhere. Also, note that you’ll have to pay interest rates for it.
What are the Risks When Yield Farming?
Of course, there are risks involved that you should be aware of. After all, you can’t make a significant amount of money from investments without taking some risks.
Risks When Borrowing and Lending
You could experience impermanent loss when providing liquidity. Impermanent loss happens when the price of your token drops due to an economic recession. So your tokens might be valued less by the time you withdraw them. Furthermore, when a crash happens, the platform could liquidate your funds to cover the lender’s funds.
The downside of a Liquidity Provider
Aside from the risk of impermanent loss, becoming a liquidity provider on its own is risky. A liquidity pool that seems legit and performs well would attract more investors, thus, resulting in a decrease in interest rewards earned. Because as more people invest in it, more people will divide whatever profit that pool makes.
Risks When Staking
Usually, when you see an impending crash, you could pull out your funds to safety right away.
But when you stake your tokens, it stays locked for a certain period, and you won’t be able to withdraw them if something happens. And that is the downside of staking.