Yield Farming is not a strange term in the DeFi world, but many people do not really understand it. To make a good investment in DeFi, we should understand the basic knowledge of it to maximize profits and prevent risks. Let us find out more about Defi in this article.
What is Yield Farming?
Traditional farmers who apply new technology to increase productivity and profits (Yield) on their fields. Unlike this, in the yield farming form of the DeFi world (Decentralized Finance), farmers or Liquidity Providers (LP) are trying to expand their “yield” by increasing interest on their crypto assets when these assets are added to Liquidity Pool on DeFi platforms, such as Compound, Aave or LaunchZone (Bscex).
What makes Yield Farming a hot trend?
Yield Farming is known through the development of the COMP token – a governance token of the Compound project. This token allows holders to have the right to vote on upgrades of Compound. The more COMP tokens you own, the more right you have on the decisions of the project. The questions are how to get more COMP tokens and how to allocate the COMP token to the owner reasonably?
To solve this problem, Compound proposed a plan to distribute their COMP token by an algorithm which is providing liquidity for the protocol. When users give their digital assets to the protocol, they can receive additional COMP tokens, which increases their total number of COMP. The number of new tokens users receive will be distributed proportionally to the initial assets that users deposit into the protocol. Therefore, if you believe in this project and want to have more COMP tokens, you should add as many tokens as possible to the protocol.
Although Compound did not invent “Yield Farming”, but this form of token distribution creates a new page for the DeFi system. Many DeFi projects have improved Compound’s token distribution to “Yield Farming” to attract liquidity to their ecosystem.
What is Liquidity Pool in Yield Farming?
Liquidity pool is a smart contract that contains coins or tokens. Before going to more details about Liquidity pool, we should understand the concept of the Automated Market Marker (AMM) model. Some of the popular current AMMs are LaunchZone, Uniswap or Pancakeswap.
Like centralized exchanges, AMM has many different trading pairs but the difference is that there are no buy or sell orders. Traders do not need to find buyers on their own, instead, the smart contract works with the function of creating exchange transaction.
Although there is no need for intermediaries, it is a must to create a market and provide liquidity. This is done by the liquidity providers. If you want to exchange USDT for BSCX, you will exchange it with the Liquidity pool. USDT is transferred to the Pool from your wallet, and you will receive BSCX from the Pool. A similar process is applied for exchange BSCX for USDT.
What if someone wants to exchange 100,000 USDT for BSCX but the amount of BSCX in the Pool is not enough? This question shows us the importance of having more liquidity providers.
Benefits of the Liquidity provider in yield farming
The revenue of the Liquidity pool is from the transaction fee when end-users make transactions, such as borrowing, lending, and exchanging coins. This revenue will be re-distributed to the liquidity providers according to the proportion of the liquidity they provided into the pool (the share of the pool).
Apart from transaction fees, many protocols implement Liquidity mining. This new form of mining rewards profits for investors who provide liquidity into their protocol.
That is how many projects attract capital into their protocol through Liquidity Mining. With many Liquidity Mining growing extremely fast and achieving huge profits, Defi becomes hotter than ever.
How to calculate the profit from Yield Farming?
Profits from Yield Farming is usually calculated annually, the same as 1-year savings interest rate. There are two common methods to measure profits: APY (Annual Percentage Yield) and APR (Annual Percentage Rate). APY takes into account gross profit, however, APR does not. The question is how to caculate profits from Yield Farming in the short term?
In fact, estimating the profits earned from Yield Farming is difficult as this is a highly competitive campaign and many innovations as many projects try to attract investors to provide liquidity into their protocol. Therefore, profit margins can change very quickly and be difficult to accurately calculate in the short term.
An example is when a liquidity provider adds liquidity for a project. The protocol uses an algorithm to automatically calculate a certain reward. The more users entering farming, the more rewards per person will decrease, leading to a decrease in profits from Yield Farming compared to the beginning. Therefore, your actual return after one year may not be the same as the APY or APR at the time you provided liquidity for the protocol. This is not taking into account the price volatility of the asset during this time.
Besides extremely attractive profits, we also need to consider the risks of participating in Liquidity Mining.
Yield Farming and Risks
Apart from providing high APR/APY (Annual Percentage Rate / Annual Percentage Yield), most of the Yield Farming mechanism is very complicated and requires users to do research about what they are investing in.
If we do not really understand how the protocols work, the chance of losing money is very HIGH.
Scam projects often offer very high APY, the rage of interest rates can vary from 50%-10,000%. They promise us a chance of changing life with a huge amount of money received. Many of us want to be rich in short time, so that we are easily to get into a scam project if we do not know the rules of the game.
Smart Contract Risk
Most protocols are developed by small capital teams, that increases the chance of bugs in smart contracts because of lacking budget to audit. The protocols that have been audited are still having probability of bugs or money stolen as in the case of Bzrx, Curve …
Impermanent loss occurs when you provide liquidity to the pool and the price of the token changes compared to the time you added liquidity. The larger this change, the greater the impermanent loss.
In this case, the loss means that the dollar value at the time of withdrawal will be less than at the time of deposit but be aware that the temporary loss is only the actual loss when you withdraw your LP pair from the Pool.
Therefore, it is important to choose a good project, then the Impermanent loss can still be prevented by transaction fees and profit from farmed tokens. In fact, pools on Uniswap that suffer temporary losses can also profit from transaction fees.
Đọc thêm: Impermanent loss và những điều bạn nên biết.)
Featured Yield Farming projects
Yield Farming has created a new opportunity for users to receive attractive rewards from DeFi projects. However, each project will have different Yield Farming campaigns that you should research before investing your money in it because sometimes the profit you get will not the same as you expected. In the next section, we will introduce you to some of feature Yield Farming projects with different campaigns.
Compound is a project providing loan and loan services. When users provide liquidity to Compound, they will receive a COMP token reward. The interest rate changes according to the law of supply and demand. About 2,312 COMP tokens are distributed daily to users through different markets cooperated with Compound (ETH, DIA, BAT, etc.), however, with different interest rates on each market. For each market, 50% of tokens will be distributed to liquidity providers, the remaining 50% will be distributed to borrowers.
MakerDAO is a decentralized lending platform where users can create its Dai token – a stablecoin pegged to the US dollar. Users can add supported crypto assets (ETH, BAT, USDC, etc.) as collateral into the protocol to create Dai token as a loan from their collateral. The Dai can be used for Yield Farming in other DeFi projects, such as Compound.
Synthetix is a synthetic asset protocol. Users can deposit their assets on other protocols, usually, SNX or ETH, to create synthetic assets such as sUSD and sBTC. You can then use these synthetic assets to provide liquidity to other protocols on the ETH ecosystem to farm new tokens and receive transaction fees.
Aave is a decentralized money market protocol in which users can lend and borrow tokens. Users will receive aTokens corresponding to the amount of underlying asset they put into the protocol to receive interest. Besides, Aave allows users to borrow flash loans. Borrowers can access loans more quickly without collateral, but they must repay the loan before the end of the same transaction. Borrowing allows farmers to have more assets to farm.
Uniswap is a decentralized exchange that allows users to quickly swap tokens. In Yield Farming, users need to provide 2 types of assets, which are equivalent in value, to create a pair of tokens to provide liquidity for transactions. The reward is the transaction fees getting from that liquidity pool.
Curve Finance enables users to swap between stablecoins with minimal slippage. In addition, users can provide liquidity to Curve farm CRV tokens and receive transaction fees from the liquidity pool.
Balancer is similar to Uniswap and Curve Finance. However, Balancer has a unique feature that allows users to allocate their own investment to a token pair at a suitable rate instead of a fixed rate 50/50 like Uniswap. After providing liquidity to the liquidity pool, users receive transaction fees from traders and farm BAL tokens.
Yearn.Finance aims to optimize deposit rates through its algorithms. The system will generate the most suitable strategy to bring the best profit for the lenders. Like the above platforms, users can receive YFI tokens and transaction fees obtained from the protocol.
LaunchZone was formerly known as BSCex, a decentralized financial ecosystem that provides off-chain services to on-chain users with benefits. Apart from low transaction costs, users can experience LaunchpoolX feature to farm new tokens. Users will provide liquidity to a liquidity pool with a pair of tokens with equivalent value, for example, BSCX – BNB, to receive new tokens with the proportion of their liquidity pair contribution. In addition, after re-brand from BSCex, LaunchZone also introduced many new potential development features such as PadX, DexX together with SwapX and PoolX.
LaunchZone has been very welcomed in the Vietnamese market since the end of 2020. They are implementing many Marketing campaigns to reach international markets, together with their product development plan. LaunchZone is considered having a high growth potential compared to other products that were widely known in the past.
There are many DeFi projects on the market that provide Yield Farming for users. In order to make a smart investment decision, you need to understand how Yield Farming works as well as the possible benefits and risks. High returns will always come with high risks. Be careful and wisely with your decision.