The crypto industry has become one of the fastest-growing markets today. Despite being at odds with regulatory bodies across the globe, it has grown immensely with more than a trillion market cap. Even with a market crash, the industry has offered lucrative investments for investors. One of the most significant investments to earn passive income in crypto during a dip includes cloud mining, joining referral programs, buying and holding crypto assets, and yield farming. In this article, we will focus more on yield farming. We will give you an overview of this type of passive earning and travel back to where it started. So, first things first. Basically, what is yield farming?
Yield farming is another product of decentralized finance (DeFi) where investors can earn passive income by committing token pairs to a decentralized platform. The amount they will receive will depend on the number of their delegated tokens. The boom of yield farming in a bearish or even a bull season has attracted many investors, including newbies. But how did yield farming start?
Yield farming was first introduced in the market in 2020 by Compound, a decentralized protocol built on the Ethereum network. The platform has distributed its governance token COMP (Compound) to users which enables them to vote for any proposed changes in the platform. With more users wanting to take part in the voting process thus creating demand, the price of the token skyrocketed. This paved the way for the rise of yield farming we know today. To join this program, users can choose from the different types of yield farming. What are these?
Here users delegate a particular number of cryptocurrencies to a blockchain network to validate and transaction processing. It works more on the technical side since it also aims to protect the network from fraud and errors. By locking their cryptocurrencies, users receive cryptocurrencies as rewards. In short, with staking, you need to lock up your cryptocurrencies and you can either choose from a flexible or fixed lock-up period. With flexible, you can unstake your tokens anytime while with fixed, you wait until the defined lock-up period ends before you can unstake them.
By committing a pair of tokens to a decentralized exchange (DEX) as trading liquidity, users become liquidity providers. The fees collected from users on the platform are then distributed to liquidity providers as rewards.
Users lend their tokens to a DeFi platform for crypto borrowers using a smart contract and in return, they receive interest from the borrowed crypto asset.
Here users can get a loan using one token to farm yield and use the other as collateral. By doing this, they will be able to keep their initial holding while waiting for prices to go up.
Annual percentage rate (APR) and annual percentage yield (APY) are used to calculate an investor’s rewards in yield farming. APR refers to the interest applied on an amount per year which can be calculated as follows:
(Outstanding Loan Principal) × (APR ÷ 365)
APY on the other hand annual return on an investment that includes compound interest accrued on top of your initial investment. Below is the formula for calculating APY.
APY = (1 + r/n)ⁿ − 1
r = periodic rate of return (or annual APR)
n = number of compounding periods each year
Although yield farming is a lucrative investment, it also presents risk due to cryptocurrency’s volatility. Also, since most yield programs are run into the DeFi space, there is always the risk of falling victim to a scam. This is on top of the rampant cybersecurity attacks involving DeFi protocols that offer yield farming to users. As an investor, it is always best to do your due diligence before investing in any of its forms. In our next article, we will give you a list of the leading yield farming in the crypto market today.