As the DeFi frenzy continues apace, yield farming is arguably the trendiest issue in the cryptocurrency world. Here’s a more in-depth look at it. Yield farming has been a hot issue in the DeFi community for quite some time. We understand that you may have numerous questions about yield farming. What’s the big deal about it?
Let’s begin with a straightforward statistic. In terms of total value locked (TVL) in dollars, the DeFi space is expected to increase at a rate of 150% by 2020. In comparison, the cryptocurrency market capitalization has expanded at a pace of only 37% thus far.
Many analysts attribute this year’s phenomenal success in the DeFi market to yield farming. The notion of liquidity farming is responsible for the progress. It involves both investors and speculators, who provide liquidity to lending and borrowing platforms. In exchange, the lending and borrowing platforms pay them exorbitant interest rates. As an incentive, they also earn a portion of the platforms’ tokens.
The liquidity providers are the current stars in the DeFi space. They are known as yield farmers. Among the main names are Compound (COMP), Curve Finance (CRV), and Balancer (BAL).
Balancer Comp, Balancer Curve, and Balancer
Compound: The First to Start the Liquidity Farming Fever. It all started in June with the live release of Compound’s COMP coin.
The live distribution of Compound’s COMP token on June 14 marked the start of everything. The Compound’s governance token is called COMP. The COMP token live distribution was a huge success. It enabled the platform to lock in a total value of $600 million (TVL). For the first time ever, a DeFi protocol surpassed MakerDAO in the DeFi Pulse leaderboard.
After the COMP token was distributed, the Balancer’s BAL token was distributed. In May, Balancer had introduced its protocol rewards incentive scheme. Within a few days of COMP, they began the live circulation of their BAL token. It also had great success. They managed to accumulate $70 million in TVL.
Despite the fact that COMP is where the extreme yield farming trend first started, even if the present yield farming craze originated with COMP, this has always been an element of DeFi. The notion of protocol token incentives was invented by Synthetix. Synthetix proposed the concept in July 2019. They were paying users that provided liquidity to the sETH/ETH pool on Uniswap V1 with token payouts.
Yield Farming: The Solution to DeFi’s Liquidity Problems
What is the key concern in the DeFi space? The solution is liquidity. You’re probably wondering why the DeFi gamers want funds. For starters, banks have a lot of money, but they borrow more to operate their day-to-day operations, invest, and so on.
Strangers over the internet offer the necessary liquidity in DeFi. As a result, DeFi ventures use new techniques to recruit HODLers with idle assets. Another factor to consider is that some services need high liquidity in order to avoid significant price slippage and provide a better overall trading experience. DEXs (decentralized exchanges) are a perfect example.
Borrowing from other users is becoming increasingly prevalent. In the future, it may potentially compete with borrowing from debt investors and venture capitalists.
So, what exactly is Yield Farming?
To compare yield farming to legacy finance, think of it as putting money in a bank. Banks have typically provided varied interest rates to customers who hold their money in deposits over the years. In other words, you get an annualized interest rate for having your money in a bank.
This is akin to yield farming in the DeFi space. Users lock their funds with a certain protocol (such as Compound, Balancer, and so on), which then loans them to those who need to borrow at a specific interest rate. In exchange, the site would reward customers who locked their assets and occasionally split a portion of the fees for granting the loan with them.
The revenues received by lenders through interest rates and fees are less important. When it comes to genuine payout, the units of new crypto tokens from the loan platform take the cake. When the value of the crypto lender’s token rises, the user will make a purchase.
What Is the Connection Between Yield Farming and Liquidity Pools?
Fees are charged to liquidity providers via Uniswap and Balancer. They provide it as an incentive for increasing liquidity in the pools. As of the time of writing, Uniswap and Balancer are DeFi’s two largest liquidity pools.
The two assets are split 50-50 in Uniswap’s liquidity pools. Balancer’s liquidity pools, on the other hand, support up to eight assets. It also provides customized allocations. Every time someone trades through the liquidity pool, the liquidity providers receive a portion of the platform’s fee. Because of the recent surge in DEX trading volumes, Uniswap’s liquidity providers have received good profits.
Curve Finance Made Simple: Complex Yield Farming
One of the top DEX liquidity pools is Curve. It was built to provide an efficient way of trading stablecoins. Curve now supports USDT, USDC, TUSD, SUDS, BUSD, DAI, PAX, and BTC pairings. Curve uses automated market makers to facilitate transactions with minimum slippage.
Curve is also helped by automated market makers in keeping transaction fees low. It has only been on the market for a few months. Despite this, it is already ahead of several other top exchanges in terms of trade volume. iCurve’s performance has outperformed some of the industry’s biggest brands in yield farming.
It is currently ahead of Balancer, Aave, and Compound Finance. Most arbitrage traders choose curve since it provides significant savings during deals. There is a distinction between the algorithms of Curve and Uniswap. The Uniswap algorithm is designed to increase liquidity availability. The Curve, on the other hand, is concerned with allowing for the least amount of slippage. As a result, Curve remains a preferred choice for high-volume crypto traders.
Understanding the Yield Farming Risks
In yield farming, there is a reasonable probability of losing money. Automated market makers may be highly profitable for particular protocols such as Uniswap. Volatility, on the other hand, might lead you to lose money. Any negative price change reduces the value of your interest in comparison to holding the original assets.
The concept is straightforward, and it is only achievable when staking tokens that aren’t stablecoins since you are subject to price fluctuation. In other words, if you stake 50% ETH and 50% of a random stablecoin to farm a third token, if the price of ETH falls dramatically, you may wind up losing more money than if you simply market purchased the token you are cultivating.
For example, suppose you stake 1 ETH (priced at $400) and 400 USDT to farm YFI at a price of $13,000. (The example is not based on existing liquidity pools.) Your daily return is 1%. That is, for your $800 original investment, you should receive around $8 in YFI per day. However, because to market volatility, the price of ETH falls to $360, and you’ve lost 10% of your ETH while earning, say, $8 of YFI. If you had instead purchased $800 of YFI and its price did not change, you would have kept your worth.
Smart Contract Risks
Smart contracts may be exploited by hackers, and there have been several incidents this year. Curve, $1 million at risk in bZx, and lendf.me are just a few instances. The DeFi explosion has resulted in a million-fold rise in the TVL of emerging DeFi protocols. As a result, attackers are increasingly focusing on DeFi protocols.
The Protocol’s Design Poses a Risk
Because most DeFi protocols are in their early stages, there is the possibility of gaming the incentives. Consider YAM Finance’s recent occurrences, in which a miscalculation in the rebasing method led the project to lose nearly 90% of its dollar worth in just a few hours. Despite this, the development team had clearly stated the risks of utilizing the unaudited protocol.
High Risk of Liquidation
Your collateral is vulnerable to the volatility of cryptocurrencies. Market fluctuations might potentially jeopardize your debt situations. As a result, it may become undercollateralized. You may potentially incur additional losses as a result of inadequate liquidation procedures.
DeFi Tokens are Subject to Change
The Bubble Risk Affects DeFi Tokens. Yield farming protocols’ underlying tokens are reflexive. Their value may rise as usage increases. This is reminiscent of the early days of the 2017 ICO craze. We all know how it ended. The DeFi boom may be different; yet, most projects enjoy the excitement rather than their utility in attaining higher-than-expected market capitalization.
It’s vital to remember that on platforms like Uniswap, which is at the forefront of DeFi, anyone can withdraw their liquidity at any time unless it’s locked by a third-party method. Furthermore, in many, if not most, situations, the developers are in command of large quantities of the underlying asset and may quickly dump these tokens on the market, leaving investors with a bad taste. The most recent example comes from a promising business called Sushiswap, where the primary developer sold his tokens worth millions of ETH, instantly dropping the price of SUSHI by more than 50%.
Yield farming is the latest craze among cryptocurrency enthusiasts. It is also bringing a large number of new people to the world of DeFi. However, it is important to remember that there are substantial hazards involved. Impermanent loss, smart contract risks, and liquidation risks must all be considered. Even if it is highly profitable, it is critical to examine these risks and only utilize funds that you can afford to lose.