Decentralized finance gives cryptocurrency holders many options to make money. One popular concept as of late is DeFi yield farming. This term has sparked quite a bit of confusion, yet it seems that the process is relatively straightforward.
The Process of DeFi Yield Farming
Having a broad understanding of decentralized finance is not something everyone possesses. For those new to the industry, DeFi may seem very daunting and confusing. This is especially true when buzzwords are being thrown around that might not make sense at first. A term such as DeFi yield farming will unnecessarily confuse newcomers, thus an explanation is in order.
Investors contributing funds – or liquidity – to decentralized finance projects are eligible for rewards. Depending on which protocol, platform, or company one contributes liquidity to, these rewards can be very different. Leveraging the different rewards across multiple platforms is what DeFi yield farming is all about.
Considering how decentralized finance projects generate high returns, it is always an option to explore the different options. Not just in terms of maximizing those returns from a specific platform, but also determining if they can be leveraged for even more money somewhere else.
At its core, DeFi yield farming revolves around earning high returns on crypto assets and compounding them. Adding layer upon layer of earnings will quickly grow a portfolio from “minor” to ‘substantial” if done correctly.
Again, it requires a very good understanding of how these platforms work, what they offer, and whether an opportunity is worth exploring. Making the wrong decision can still lead to major financial loss, which needs to be avoided at all costs.
A Brief Example
Explaining what DeFi yield farming is all about can best be done by looking at an example.
Assume an investor has 50 Ethereum as part of their portfolio. There are many options to obtain returns on Ether, but it is not the most flexible asset.
One option is to use this ETH balance to “generate” a stablecoin such as DAI. Rather than using an exchange or a swapping service, that investor opts to use MakerDAO. With 50 ETH – currently valued at over $11,000 – the user can generate $7,333 in DAI. This ratio is influenced by MakerDAO’s ratio of collateral, which currently sits at 150%.
Obtaining DAi gives the user more opportunities within the DeFi ecosystem. One potential option is to use DAi and take out a loan in a different cryptocurrency utilized within decentralized finance.
In some cases, it can be more lucrative to use a stablecoin – such as DAI – for loans and using the borrowed asset to generate rewards from a different service provider. Compound has proven to be of great interest in this regard.
NOTE: Borrowed money is subject to interest rates, which need to be deducted from any potential profit one makes. If the profit is lower than the interest rate, the option isn’t worth exploring at all.
Its native COMP token has seen a massive surge in value, making returns obtained in COMP of higher value compared to the amount of money borrowed. As such, users farming COMP rewards – through InstaDapp – make a profit by borrowing crypto assets from a different platform.
The YouTube video below explains the entire process in a lot more detail.
Should Everyone do it?
In theory, there is no reason for people not to put their money to work through DeFi yield farming options. However, going in blind is never a good idea, as it will lead to financial ruin sooner or later. The Defi industry is very complex, perhaps even more so than traditional finance. Getting the lay of the land is crucial, as there will always be some potential pitfalls that need to be taken into account.
Maximizing the profit potential of one’s crypto holdings will always be a risky option. There is good money to be made with sufficient knowledge and the right market conditions. Given the volatility of the crypto industry, that latter aspect may prove a lot more difficult to come by than one may think.
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