Yield farming simply refers to the act of lending or staking cryptocurrencies to generate rewards from investment. Generally, these rewards are usually paid in the form of crypto assets. However, the value of dividends paid out is dependent on the value of cryptocurrencies that yield farmers stakes.
Yield farming is an aspect of decentralised finance that relies on smart contracts for its operation. Although yield farming offers rewards to investors, this aspect of decentralised finance has begun to gain more traction due to several other unique innovations like liquidity mining.
Among many other things, yield farming platforms motivate crypto investors to lend or stake their tokens in a liquidity pool operated by smart contracts. Through this process, crypto investors on yield farming platforms act as liquidity providers.
Rewards for acting as a liquidity provider on a yield farming platform varies. In some cases, incentives may come as a portion of transaction fees on the platform. At other times, liquidity providers will receive interest in the form of newly minted tokens or a governance token.
It is vital to note that a higher number of investors or liquidity providers in a liquidity pool will result in smaller rewards for users. Generally, all rewards available on a yield farming protocol are APY’s or annual percentage yield. We will discuss more annual percentage yield shortly.
During the early days of yield farming, most liquidity providers only staked popular stablecoins like DAI, USDC, and USDT. However, several decentralised exchanges now offer crypto investors the opportunity to serve as liquidity providers on their platform by staking and locking a wide range of digital currencies. Most DEX protocols utilise this process to deliver liquidity to their exchanges.
The development of yield farming has led to creating a new avenue for wealth generation within the DeFi space. The growth of this sector has been so immense, with an increase in market cap from around $700 million to over $10 billion within 2020 alone.
The Role Of APY In Yield Farming
APY plays a vital role in determining the value of rewards liquidity providers’ receive for staking, lending, or locking their assets in a liquidity pool. The annual percentage yield is simply the rate of return on a specific investment within the space of one year. In most cases, compounding interests are calculated regularly and included in the annual percentage yield meant for liquidity providers.
Generally, the APY’s for well-established yield farming protocols are usually low. This factor can be attributed to the high number of liquidity providers on such platforms. To make up for the shortfall in rewards, numerous yield farming protocols mint and compensate liquidity providers with token rewards.
Many other yield farming platforms deliver their governance tokens to liquidity providers on their platforms. These governance tokens can be traded on various centralised and decentralised exchanges.
There are many excellent yield farming protocols within the DeFi space. Some popular protocols include Aave, Uniswap, Compound, Sushiswap, Pancakeswap, and Curve Finance. All of these protocols deliver excellent staking opportunities to crypto investors.