ELI5: Crypto Yield Farming
Seeing ridiculous APYs on certain Yield Farms and wondering if its a scam? This article gives a simple ELI5 to hopefully aid in your investment decisions in Cryptocurrency!
What is a Yield Farming Protocol (YFP) & how does it work?
Summarized in 3 pointers:
- 💰 Lending out your crypto assets in DeFi (Decentralized Finance) Protocols to earn interest. These protocols run on the Ethereum network and utilizes popular ERC-20 tokens like DAI, USDC, & ETH. Most recently, there are some protocols that utilizes the Binance Smart Chain.
- 🏦 Working like a bank where loans (using funds deposited from individuals like you and me) are provided to borrowers & interests is collected on those loans. In comparison to Yield Farming, liquidity (your money) is provided to a liquidity pool (the bank), for example, the BAT-BAKE pool (courtesy of Bakeryswap.org) and the specific governance token (interest) will be rewarded to the liquidity provider based on how much liquidity they have provided. In this case, BAT-BAKE BLP token will be rewarded.
- 💸Following the previous point, the tokens themselves can be further pooled into another liquidity pool to hopefully earn even higher yields than before, in turn providing different reward tokens; or in layman terms — re-investing to potentially earn higher returns.
Simply put, just over a period of 2.5 years from 2017, value locked into YFPs broke the $1 billion mark, surging back down in early 2020 and then rocketing to over $2 billion in July 2020, finally breaking the $3 billion mark 2 weeks later.
High returns are attracting investors from all walks of life to make big bucks from their crypto assets in a short period of time. However, it does carry its own set of risks.
Additionally, being DeFi, investors have a certain ‘control’ over their assets as they recognize that no one in the chain/networks owns their investments.
HIGH RISKS ABOUND!
High rewards certainly come with high risks. YFPs usually come with these common risks below:
- Smart contract risk. ELI5: Bugs in code of smart contract bad. Bugs bring down token price. Read article below.
- Big vs small investors. ELI5: Heard of ‘Whales’ in Crypto? In YFP, when a whale makes a massive move like the creator of SushiSwap who liquidated his share in the liquidity pool, which he returned the amount thereafter — but not without repercussions before the return.
- Price Risk. ELI5: Make big bucks after several advantageous moves in different strategies. Make one mistake (which is not caused by yourself), e.g YAM-YFP, and all your gains vanishes overnight.
- Gas fees. ELI5: Self-explanatory. Strategies running on the ERC-20 network are likely to incur high gas fees due to current congestion in the network. Therefore, investing even $20 doesn’t make sense when you are paying more than $20 in fees.
- Strategy risk. ELI5: DYOR! Strategies that work today may not work tomorrow, or even the next hour.
Yield Farming is another way that you can make your crypto work hard for you instead of riding the ups and downs in the market, or through simple strategies like Dollar-Cost Averaging (DCA).
There are many protocols in the market which are extremely popular in the market now like Uniswap, Bakeryswap.org, Beefy.Finance & Pancakeswap.Finance. I intend to write on how you can potentially grow your BAT through Bakeryswap next week, so hopefully, this article gave you a good introduction to the world of YFPs.
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**Disclaimer: What I am providing is not financial advice. The thoughts expressed here are meant for your own research purposes. Always, ALWAYS conduct your own research into the variety of options out there before you come to a final decision