Yield Farming is the defining investment option in the DeFi sector. When it comes to generating profits, it is hard to find a better approach. The core idea behind this method is that decentralized protocols can attract liquidity providers at a relatively low cost by offering native utility or governance tokens as rewards on top of tiny yields in base assets. As the crypto market is largely speculative with volatility reaching 10% and even more for less stable coins, investors can extract massive profits given they time their exit correctly.
The concept of decentralization is not novel to many computer science enthusiasts. The first attempts at creating distributed, ungoverned networks were made in the late 1980s. Bitcoin was a logical extension of the ideology that started forming as we were getting closer to the 2008 financial crisis. Many people during that era quickly jumped on the hype train with the name Bitcoin on it.
Ethereum is the next step in the development of the decentralized global economy. The digital architecture of this blockchain allows developers to deploy their code and build on top of the foundation which is now known as Ethereum Virtual Machine or EVM. Decentralized protocols use simple or audited smart contracts to automate various operations and transactions to create a trustless and permissionless environment where the counterparty risk is nil.
Without the need for constant supervision and bureaucracy, administrative costs are very low. It means that transactions are cheaper compared to the world of tradfi or even CeFi. Many enthusiasts are using this advantage to significantly reduce fees and trade at favorable rates using various decentralized exchanges.
All decentralized protocols require liquidity to operate. Whether they are focused on swapping tokens, sending assets across different chains, or lending coins, they need funds to work. While centralized entities raise capital and use it to facilitate trades, DEXes are often independent projects that cannot acquire funding directly from venture capitalists.
They have to resort to other methods of acquiring liquidity. The most common system is to pay liquidity providers with a cut of revenue. The intense competition in the sector with over 1,400 different DEXes leads to a situation where relatively low yet consistent APYs are insufficient to attract massive crowds of potential investors. This is where we start talking about yield farming.
A DEX or AMM platform that wants to attract more liquidity can simply start issuing native tokens and give them some sort of utility such as discounts, bonuses, or other perks. Depending on the popularity and user activity on the platform, its tokens can be very valuable.
Below are three types of different tokens that can be issued as rewards by such protocols:
Note that DEXes and AMMs are not the only yield farming protocols that allow users to receive rewards for staking in their pools. Many yield aggregators also have different pools that grant tokens. For example, Cetus AMM offers a variety of rewards to users who want to invest in automatic market-making protocols. AMMs are hugely important for the DeFi sector as they are pivotal components in the gas fee optimization processes.
Financing in the decentralized finance sector is done via automatic lending where users provide collateral to cover the cost of a loan that usually amounts to less than 80% of the collateral’s value. While many users who are not experienced in the world of DeFi might think that there is no purpose in taking out an overcollateralized loan, it is a useful instrument for people who want to switch investment focus without liquidating a position.
Flash loans are also quite popular. These are uncollateralized loans that must be repaid before the transaction is settled. Again, these can be incredibly useful if you are interested in various types of DeFi investments and need immediate funding.
Many lending platforms offer good rewards to users who act as providers of liquidity:
One of the best ways to optimize the profitability of investments in the DeFi sector is by using various protocols that allow you to receive rewards and interest rates in the most sensible manner. For example, you could focus on the following strategies offered by Rivo.xyz, a premiere DeFi marketplace with various options for all sorts of portfolios.
Another good approach is to invest with yield aggregators that can quickly switch between different protocols and move your assets effectively to secure the best profits and rewards. While their APYs are usually lower compared to target protocols, the dynamic movement of digital assets allows them to achieve better outcomes on average.
Below are some examples of such protocols:
Many contemporary investors are entering the DeFi sector without any prior experience with crypto or financial markets in general. It is critical to continuously research the industry and its many instruments before making a move. We want to give you several useful tips and suggestions to make your journey through the ecosystem smoother.
These tips will help you build a strategy for yield farming. We strongly suggest focusing on researching the industry before heavily investing in decentralized protocols. Smart contract farming can be incredibly rewarding, literally and figuratively, but it can also expose your portfolio to risks that you have never encountered before!
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