Yield Farming is an easy method to earn rewards by staking or lending the crypto coins you have with you. Your assets will be added to the respective liquidity pools and rewarded with cryptocurrencies or governance rights on the platform. Yield farming was a critical method for earning rewards and incentives until the downfall of the stablecoin TerraUSD in 2022. After this event, yield farming is being selectively used by investors.
In this article, you will learn more about yield farming, how it works, and its significance in the cryptocurrency market.
What Are The Factors That Contribute To The Working Of Yield Farming?
The exact procedure of yield farming differs from protocol to protocol, but its general working is uniform across all platforms. The yield farmers deposit the tokens in their hands on major DEXs or yield farming platforms such as Uniswap, Aave, or Pancakeswap. They are rewarded in terms of annual percentage yield (APY).
The process of investing in a yield farming platform is given below.
- Select a yield farming platform that is easy for you to use.
- On the platform, choose ‘liquidity’ to access the platform’s liquidity sharing function.
- From the list of different assets given on the platform, select the asset you would like to invest in.
- After completing the yield farming process, you will be provided a liquidity provider (LP) token, which you can surrender at the yield farming platform to earn rewards for staking your tokens on the platform.
Why Does Yield Farming Matter?
Yield farming is an important part of increasing the liquidity of the cryptocurrency markets. It has many benefits for the liquidity providers as well as the platform. The rewards that the liquidity providers get are a good means of earning passive income from cryptocurrencies, which are otherwise a locked asset for them unless they earn by selling it. The yield farming platforms can get the benefits of being prominent liquidity pools with a comparatively low investment.
- Passive Income: As discussed above, yield farming is a source of passive income to the liquidity providers who stake or lend the tokens in hand to facilitate liquidity on a public platform.
- Enable the smooth functioning of the DEXs: The liquidity providers ensure that the DEXs are run smoothly. The increased liquidity on the platform provides efficient trading solutions without causing any slippages.
- High Yields: The yields that the liquidity providers earn in return for staking the tokens can be higher than those earned through other investment methods, depending on the market conditions.
What Are The Risks Associated With Yield Farming?
Despite the various benefits that yield farming offers, this method of staking also has certain inherent risk factors.
- If such a situation occurs where the price of a certain coin in the liquidity pool fluctuates heavily, the platform will sell the expensive tokens and buy the less expensive tokens to balance the price of the coins on the platform. At such times, the liquidity providers who provided the high priced tokens would incur a temporary loss.
- The demand and supply of the tokens will result in changes in their prices, which will in turn affect the percentage of yields that the liquidity providers will earn.
- Another major risk of investing in yield farming is the volatility of cryptocurrency prices. The price volatility of the crypto tokens can affect the tokens staked in yield farming. If the token you have staked starts trading at a loss, then your profits on the platform will be affected.
Also, Check: Liquidity Mining in Crypto
The Bottom Line: Is Yield Farming A Profitable Investment?
Yield farming is a viable way of earning a profit for the cryptocurrency tokens in your custody by staking or lending them in exchange for rewards. But you should not overlook the risks that this investment method puts forward.
Even if you are trading on an authorized, highly reputable DeFi network, your outcomes can be affected by the changes in the market conditions and the price of the tokens. The high yields that you receive today may not be long-lasting and can dip in the future. So, if you want to earn high profits in yield farming, you should make investment decisions in tune with the market conditions.
