One of the hottest topics in the crypto community right now is yield farming and its many forms. Investors have access to a wide range of tools capable of producing profits passively. It seems like a dream investment to many newcomers who do not yet understand the dangers of the crypto market. Learning the nuances of investing in this complex ecosystem can be very demanding. The DeFi sector features over 13,000 pools, several hundred different investment platforms, and a whole cohort of novel instruments unfamiliar to many beginners.
This incredible complexity often confuses those without any prior experience in financial markets. Even seasoned veterans feel overwhelmed. The lack of education among investors also plays a huge role. A study by Preply revealed that over 60% of all crypto holders do not understand how blockchain technology works. It is a concerning statistic considering that all decentralized protocols are deployed on blockchain and extensively use its features.
Let’s start with clearly defining the terminology that we are going to use in this article. Here are some terms that you need to understand or align their descriptions with what you are about to read:
A DeFi protocol is a specialized platform that operates pools with investor funds that are used for various purposes to generate revenue. They can be programmed to lend assets, supply liquidity to automatic market-makers, and more.
An investor can use their digital assets in a variety of ways. Whenever they lock in capital in exchange for rewards, we call it yield farming. There is also another definition that specifically refers to an investment practice where you lock in funds and receive native tokens issued by the target protocol as rewards. For instance, you can invest in a BUSD-DAI pool on Goose Finance to receive native $EGG tokens as a reward at an 18.34% APY.
We are going to talk about the more general definition which refers to the selection of different approaches focused on generating passive income using cryptocurrencies.
Using PoS protocols and becoming a validator by running a node or joining a pool is often classified as a completely separate investment instrument which is fair as staking involves locking in funds directly on layer 1. Many investors believe that using layer 1 staking options is a safer route for capital allocation with blockchains like Ethereum or Bitcoin appearing trustworthy and reliable.
While returns on investments can be incredibly lucrative during bullish trends since your assets continue appreciating while generating additional tokens, profits plummet when prices go down. Interest rates in staking are close to that of US treasury bonds or high-yield bank accounts. For instance, the average return on ETH is 4% which is lower than US treasury bonds (4.11% in 2024) or the average return on deposits (close to 5%).
Investors engaging in yield farming in decentralized finance are often chasing higher rewards and exposing themselves to the corresponding level of risk. It is possible to achieve APY on base assets that reach double and triple APY on bonds. A good example is liquid staking and restaking on Ethereum. You can receive stETH on LIDO while earning 2.95% base APY and restake it on Kelp DAO for 3.04% APY while getting additional EigenLayer points and Kelp Miles which both provide utility and value to users of the Kelp DAO platform. The total comes to 5.99% APY.
It is important to look for ways to improve gains. While some investors are happy with APYs that beat what tradfi can offer, smart capital holders do not like the idea of having an idle investment that could generate more. Exploring the complex world of decentralized finance is a time-consuming endeavor with many protocols offering unique schemes that require additional research and, often, first-hand experience.
Since the variety of investment tools can feel overwhelming, it is a good idea to have a system that allows you to quickly scan through the sector in search of a good target for capital allocation. Let’s discuss one of such approaches.
To reach the biggest yield number without overexposing a portfolio, one must follow a set of simple rules. These are just tips to help you pick the right investment option while avoiding some risks. However, they just cover the fundamentals and cannot be used as financial advice.
Here are the rules that you should follow when trying to build a portfolio that generates high interest rates:
Let’s talk about some interesting methods of generating high interest rates. We will also cover a specific method of yield farming as a more specific approach involving earning native tokens. Note that we are not giving investment advice or endorsing any of the platforms mentioned throughout the article.
Here are some interesting strategies to use:
It is important to stick to projects that have a proven track record. While it is impossible to predict the performance of any given new project, you should either:
If you follow the first route, focusing on reading the news and actively participating in communities on Reddit and Discord should be a priority as you must be among the first investors and hope to cash out when the price rises to an acceptable level. Limiting position sizes to the bare minimum is a good idea since many of promising protocols fail spectacularly.
More conservative investors often wait until the price somewhat stabilizes to decide whether they want to invest in a protocol and start accumulating native tokens. In such cases, estimating the effect of inflation on the price is quite important. You should consider potential price dips when calculating profits.
Selecting the right protocols for investment activities is hugely important for the long-term success of your operations. With hundreds of active projects to choose from, picking platforms that are capable of producing good yields is a challenge even for experienced veterans. The sheer number of tracked pools can feel overwhelming. For instance, DeFiLlama has over 13,000 pools across 200 protocols and over 30 chains. This variety is simply overwhelming.
Unlike yield aggregators like Rivo.xyz or DEXes such as DeDust or Uniswap, protocols that focus on farming do not have the same range of functionality or versatility. People do not come here for the utility although many farms are offered by decentralized exchanges. Yield farming is more about trying to maximize potential profits and chasing big numbers. Many experts do not believe that it is a good long-term investment strategy.
You should keep all of the above in mind and make a selection based on your preferences. Here are some tips that may work for your particular portfolio:
Here are some projects that you should check out:
All investors must remember that the crypto industry in general is a dangerous place for someone without any experience or willingness to learn and improve continuously. The prevalence of purely speculative digital assets, complex multi-faceted investment schemes, maturing technology, and other issues may prevent you from achieving your goals even if you follow all traditional tips like diversifying your portfolio, hedging positions, and doing your own research.
Risks in crypto yield farming include technological imperfections of smart contracts, impermanent loss due to price fluctuations, rug pulling by protocol founders, the absence of a regulatory framework protecting consumers, and more. Navigating this complex landscape is quite hard even for the best investors with years of experience in retail trading and financial management. Newcomers are strongly encouraged to learn and expand their knowledge!
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