Yield farming is the use of cryptocurrencies to generate, earn, and collect crypto rewards.
In more familiar terms, yield farming allows investors to earn crypto like one might earn interest on money in a bank savings account.
However, the term yield farming implies a more active process. Though the term originally described the metaphorical process of “planting” crypto in a protocol to “grow” and then “harvest” the earned crypto, it also conveniently describes how many DeFi users mimic the behavior of real farmers by rotating their crops.
These yields are typically measured as Annual Percentage Rate (APR) or Annual Percentage Yield (APY), with APY accounting for compounding interest.
How does yield farming work?
Yield farming consists of ‘farmers’ using their funds in one of three main methods.
Staking
Staking is the process of allocating cryptocurrency to a Proof of Stake network—like Ethereum, Cardano, or Solana—to secure the blockchain, validate transactions on the network and earn rewards.
- Benefits: Reliable and consistent returns.
- Limitations: Staked assets may have a lock-up period, meaning it could take days or weeks to unstake coins after deciding to withdraw the funds.
Lending
Lending cryptocurrencies to other users is a common practice in DeFi. By lending tokens to borrowers through platforms like Maker or Aave, farmers earn the right to collect interest from them.
This mirrors the traditional financial system, but the rates are set almost exclusively by supply-and-demand dynamics rather than by third party institutions.
Providing liquidity
On DEXs that use an automated market making (AMM) system (like Uniswap or Curve), liquidity providers deposit assets into liquidity pools for traders to swap against, while paying a small fee for the service. These fees are then distributed to all liquidity providers.
Liquidity pool rewards can be paid in the form of pool assets (e.g., DAI in an ETH/DAI pool), or in the form of a platform’s unique token (e.g., UNI for Uniswap). Some protocols even issue liquidity provider (LP) tokens to depositors, and these LP tokens can be staked on the platform for compounded rewards.
Where does the yield come from?
Yield is typically generated through a combination of:
- Transaction fees earned by providing liquidity or staking assets.
- Protocol rewards distributed by DeFi platforms.
- Borrower interest through lending cryptocurrencies.
In the early days of DeFi, platforms often supplemented organic rewards with venture capital funding to attract users, but this trend has shifted as the market matures.
The yield farming process: an example
Imagine a lending protocol that offers 5% APY on the DAI stablecoin. A user can deposit 100 DAI to take advantage of that yield.
However, they learn that a DEX offers 8.5% APY for DAI deposited into a liquidity pool. Because the user wants to optimize their crypto rewards, they move their 100 DAI from the lending protocol to the DEX.
If the DEX’s DAI APY ever goes below 5%, they can rotate their original purchases, plus earnings, back into the lending protocol. In doing so, they become a yield farmer.
Popular Platforms for Yield Farming
Staking platforms
- Blockchains: Ethereum, Cardano, Polkadot, Solana, Polygon, Avalanche.
- Methods: Direct interaction with smart contracts or staking via wallets.
Lending platforms
- Decentralized applications (dApps): Maker and Aave.
Liquidity providers on DEXs
- Uniswap: AMM platform rewarding liquidity providers with UNI tokens.
- Curve: Focuses on stablecoins with high liquidity and low slippage.
- Others: SushiSwap, Compound, Balancer.
Yield aggregators
- DappRadar: Tracks and categorizes dApps by blockchain and type.
- DeFi Llama & DeFi Pulse: Monitor Total Value Locked (TVL) and yield opportunities across DeFi platforms.
Yield farming essentials
- Yield farming involves using cryptocurrencies to generate rewards, similar to earning interest in a bank. It includes methods like staking, lending, and providing liquidity, offering opportunities for reliable returns and active asset management.
- Farmers earn yield through transaction fees, protocol rewards, or borrower interest. Methods include staking assets to secure blockchains, lending to collect interest, and providing liquidity on decentralized exchanges (DEXs) for trading fees.
- Yield farming opportunities are found on staking platforms like Ethereum and Solana, lending platforms like Aave and Maker, and DEXs like Uniswap and Curve. Yield aggregators like DeFi Llama and DappRadar help users track and optimize opportunities.