Yield Farming, also known as Liquidity Mining, is one of the many popular activities on decentralized finance. It is an activity similar to staking where you “lend” your cryptocurrency tokens (“tokens”) to an exchange and get rewarded with more tokens in return.
Why invest in DeFi Yield Farming?
It is a good entry point for beginners in cryptocurrencies because the process can be as simple as a click of a button, but others can be more complicated.
It provides fairly decent gains in the form of passive income without requiring technical knowledge. The rate of returns is expressed in the Annual Percentage Yield (APY).
You can earn from the investment, even as you are sleeping because it is low maintenance.
Most platforms have “auto renewal” or “auto investment” features that will keep the rewards coming in until you decide otherwise.
You take home a higher return of investment than staking (but it comes with higher risks, too)
In a way, you help DeFi prosper because when you lend or lock in your assets in the platform, those funds will be used as liquidity. An exchange with good liquidity means faster and more cost-effective transactions.
How does it work and how can I earn?
Many exchanges offer yield farming, but there are also stand-alone decentralized apps (dApps) that offer it today. You can lend your crypto to the liquidity pool in any of these platforms, which other investors can borrow for their own use. In return, you get a percentage of the fees in the form of crypto or you can earn interest depending on how long you lend the funds.
It provides better returns than your traditional financial institution, which may only offer 1–2% interest rates vs up to 20% in yield farming. Keep in mind to focus on the fundamentals of the project, and not just on the sky-high rewards and yield it offers.
It encourages community participation and the growth of the project. You see yield farming offered by a lot for new projects to sustain their development. As an early adopter of the project, you can also get rewarded with their native token or governance token apart from earning interest.
Are there risks involved?
Like any other investment, there are risks involved. Some overlap with a lot of the risks you are already exposed to if you’re used to centralized exchanges and other blockchain projects.
Volatility and impermanent loss — Volatility speaks of price changes of the asset and it can be highly volatile with market-moving news like large-scale hacks or regulatory changes. Meanwhile, impermanent loss happens when the value of the asset you deposited in a liquidity pool is less than when you withdraw it.
Regulatory Risks — There are industry happenings that can affect the performance of assets, such as China banning all forms of crypto transactions.
Theft and fraud — Some projects were built to con investors, which is why you should be extra careful in choosing a project. Rug pulls, for example, is a form of exit scam where developers abandon a project and run away with investors’ money.
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