What is Yield Farming in DeFi?
- Yield farming is arguably the most popular way to earn a return on crypto assets. Essentially, you can earn passive income by depositing crypto into a liquidity pool. You can think of these liquidity pools as the centralized finance (CeFi) equivalent of your bank account where you store your money, which your bank then uses to offer loans to others and compensates you with a portion of the earned interest.
- Yield farming is the practice in which investors lock their crypto assets into a smart contract-based liquidity pool like ETH/USDT. The locked assets are then made available for other users in the same protocol. Users of that particular lending protocol can borrow these tokens for margin trading.
- Yield farmers are the foundation for DeFi protocols to offer exchange and lending services. Besides, they also help maintain the liquidity of crypto assets on decentralized exchanges (DEXs). For their efforts, yield farmers earn rewards calculated as APY.
Yield Farming vs Staking vs Liquidity Mining
- Staking locks crypto for the network to function in return of fees
- Yield farming involves lending your money in return of interest through fees (like earning interest lending money to a bank)
- Liquidity Farming is when you provide crypto to liquidity pools and in return get Native/LP tokens + Governance Tokens
- Yield Farming is a subset of staking
- While yield farming supplies liquidity to a DeFi protocol in exchange for yield, staking can refer to actions like locking up 32 ETH to become a validator node on the Ethereum 2.0 network.
- Farmers actively seek out the maximum yield on their investments, switching between pools to enhance their returns.
- Liquidity Mining is a subset of Yield Farming
- The primary difference is that liquidity providers are compensated with the platform’s own coin in addition to fee revenue.