Generally speaking, there are three high-yield farming methods:
- Providers of liquidity
- Lending
- Borrowing
Providers of liquidity
When you use a decentralized exchange (DEX), you can be sure that the coin you want to swap into will have someone ready to buy it on the other side.
This is made possible by the DEX’s use of liquidity pools, a place where owners of different cryptocurrencies can lock up their holdings and earn a passive income.
In order to ease trading on a DEX, for instance, holders of $DOT and a counter asset, such as $USDT, would contribute their holdings to a $DOT liquidity pool. In exchange, the liquidity provider will receive a portion of the trading charge, which may be paid in new LP Tokens or a third coin.
Lending
It’s not that difficult. You can make interest-bearing loans to borrowers via a smart contract if you own the cryptocurrency $ATOM. A third cryptocurrency or $ATOM may be used to pay the interest.
Borrowing
This method is also fairly straightforward. For example, if you own the cryptocurrency $LINK, you can deposit your assets with a platform using a smart contract. Then, using your $LINK holdings as security, you borrow another cryptocurrency, say $ETH.
You will continue to make money as the price of $LINK goes up, and you can get even more money back from the $ETH you borrowed by lending it out to earn interest or by providing liquidity.
Farming Yield Risks
Our bare-bones examples show how Mario, the main character, in each case, can lower costs or boost his total profitability on the $ETH trade. Despite this, there are dangers associated with high-yield farming.
Regulatory Risk:
There is still a great deal of ambiguity around the status of DeFi in most places where crypto has been accepted as an asset class. Although ostensibly immune to government intervention and decentralized, these platforms serve as effective financial middlemen between borrowers and lenders. However, this kind of mediation is often regulated, and any unwelcome action by the government could hurt DeFi protocols temporarily.
Cyberattacks:
Due to the significant number of holdings locked up on DeFi protocols, these systems are a popular target for hackers. This has been demonstrated in numerous cases over the last two years. You could lose your locked funds if the procedure doesn’t work and the stolen assets can’t be found.
Rug Pulls are circumstances in which a DeFi system entices users to lock up their holdings on their platform. This attraction is frequently generated with the promise of greater than normal returns, and the protocol owner flees. This is a big risk because the DeFi market is so disorganized and not regulated.
The Final Note
Yield farming is a fascinating idea for using your idle crypto assets to increase earnings. It can also help you average down without requiring you to put more money into a downward market.
A potential yield farmer should be aware of the risks to which the DeFi industry is subject.
Due to the volatility of the cryptocurrency markets, our oversimplified examples might not always work. Furthermore, rates of return, which depend on supply and demand, could also change badly.