As time has passed, blockchain technology has been instrumental in bridging the gap between traditional financial models and its own decentralized versions, particularly within the crypto space. From utilizing cryptocurrencies for transactions to the emergence of DeFi and decentralized exchange platforms for trading, the crypto domain is rapidly closing the divide between the two financial ecosystems.
One of the newest developments in this pursuit of parity with centralized finance is DeFi yield farming. This process allows lenders to loan funds to borrowers through a DeFi yield farming application in exchange for interest.
The tremendous interest in DeFi yield farming is evidenced by statistics like DeFi Pulse’s estimate that 95% of the $41.5 billion total value locked (TVL) in the DeFi space is tied to yield farming. This explosion of interest has prompted many entrepreneurs to delve into DeFi yield farming development.
What is Defi yield farming?
DeFi yield farming is a means of generating rewards through the use of cryptocurrency holdings. DeFi protocols offer a means for users to generate high returns in the form of interest, incentives, or additional cryptocurrency by staking or lending their crypto assets. The term “farming” refers to the high interest that is produced via the liquidity of different DeFi protocols. In addition to rewards, DeFi protocols also issue tokens that represent the user’s share in the liquidity pool, which can be transferred to other platforms to increase potential gains.
DeFi yield farming is beneficial for both lenders and borrowers. For borrowers seeking margin trading, a liquidity pool can be a valuable resource, while lenders can generate passive income by investing their idle crypto assets in their wallets. Within a DeFi ecosystem, yield farmers act as banks by lending funds and utilizing tokens to generate maximum returns. The entire system operates with the help of blockchain-based smart contracts, which connect borrowers and lenders while managing investors’ rewards.
There are several key Features associated with DeFi yield farming:
Liquidity refers to the ability to convert assets into cash. In the crypto world, markets become more competitive when there is high liquidity.
- Liquidity Pool
Pools of tokens or assets that offer better returns to users than traditional money markets. They are smart contracts that lock up assets to facilitate trading through high liquidity provisions. Liquidity pools require liquidity providers to function correctly.
- Liquidity Providers
Liquidity providers refer to users who stake their deposits or invest their assets in the pool of funds. They are also called market makers as they supply what buyers and sellers need to trade. Liquidity providers receive rewards from the DeFi platform in exchange for staking their holdings in liquidity pools.
- Reward Tokens
Some liquidity pools pay rewards to liquidity providers in the form of multiple tokens. These reward tokens can be deposited into other liquidity pools for additional rewards.
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Here are the different ways lenders can get returns on the tokens they put in the liquidity pool:
There are various methods to generate returns on tokens deposited in liquidity pools. Choosing the appropriate method is crucial in developing a successful DeFi yield farming application.
- Interest in Lending Deposits:
This method involves depositing cryptocurrencies into pools governed by smart contracts in exchange for interest-earning tokens. Borrowers who take loans from the liquidity pool generate interest.
- Transaction Fees for Offering Liquidity:
By supplying cryptocurrencies as liquidity to decentralized exchanges (DEXs), liquidity providers can earn DeFi yield through transaction fees charged by the exchange. The fee is usually around 0.3%, and it is distributed among the pool’s liquidity providers.
- Token Incentives from Protocol Operators:
Compound Finance and Uniswap popularized this concept, in which protocol operators allocate tokens to current and past users of the protocol as a reward for participation and loyalty.
- Token Incentives from Pool Operators:
In this method, blockchain project owners attract liquidity providers with additional token incentives to overcome low liquidity in the pool.
Yield farmers earn a return on investment in three categories within yield farming:
- Transaction fee income:
Transaction fees vary depending on the protocols and pools used. For instance, the Balancer pool charges fees between 0.001% to 10%, while Uniswap has a flat fee of around 0.03%. All fees go to liquidity providers, and governance token holders may receive a share of the profits in the future.
- Token rewards:
Incentives in the form of token rewards are used to offer liquidity, which is distributed over a specific period, ranging from weeks to years. These tokens are often utilized to govern the system during issuance and traded on decentralized and centralized exchanges like Coinbase.
- Capital growth:
Yield farming opportunities that involve volatile assets such as BTC, REN, SNX, and CRV require adopting yield farming strategies that align positively with stablecoins. Capital growth is an essential factor in computing profitability in such cases.
How does DeFi yield farming work?
- A liquidity provider deposits their funds into a liquidity pool, which is essentially a smart contract. Typically, stablecoins pegged to the USD, such as DAI, USDT, and USDC, are deposited. The smart contract locks up these funds and makes them available within the limitations of the smart contract and the yield farming platform.
- The liquidity pool controls a marketplace for users to exchange, borrow, and lend funds. Users of the DeFi platform pay fees, which provide benefits to liquidity providers in proportion to the value of their funds.
- Liquidity providers receive rewards in fees for locking up their funds in the pool. Returns are generated in funds or tokens based on the invested amount and the platform’s protocols.
- The rewarded funds or tokens are deposited back into liquidity pools. Liquidity providers can take advantage of this opportunity by reinvesting and shifting the rewarded tokens into other liquidity pools to generate more yields. This helps the LP diversify their cryptocurrency asset portfolio, and employing a proper strategy can ensure maximum benefits from yield farming.”
Yield farming has emerged as a highly lucrative and profitable crypto investment, attracting significant attention from investors due to its high liquidity. With the increasing adoption of yield farming and the easing of regulations surrounding this investment strategy, it is gaining more and more prominence each day. The increasing popularity of DeFi platforms suggests a significant surge in the enthusiastic participation of large investors and crypto-asset holders in the future. Yield farming promises a bright future and abundant ways of generating profits in the near and long term.
At TurnkeyTown, we offer the best DeFi-based yield farming development services. Our DeFi experts have a thorough understanding of yield farming and provide optimal solutions to launch your DeFi yield farming platform or integrate DeFi-based yield farming protocols into your existing platform. If you are still unsure about how DeFi yield farming can help you make more money, feel free to reach out to our experts and schedule a meeting to discuss your business requirements.