Understanding Yield Farming Crypto

Yield farming crypto is one of the methods to get passive income from your crypto assets. With yield farming, you can profit from your crypto assets without having to sell them. This means you still hold onto your crypto assets while earning profits.

Earning profits from cryptocurrency isn't by trading activities. There are other options you can use to profit from your own crypto assets, one of them is yield farming. So, what is the definition of yield farming? We'll explain it more clearly in detail below. 

Understanding Yield Farming

Yield farming is a method of generating crypto assets from held crypto assets by lending them to DeFi platforms. The process involves depositing or lending your crypto assets to other users, and as compensation, you'll receive yields.

The concept is somewhat similar to traditional banking practices, where customer funds deposited are lent out to borrowers. Eventually, borrowers are charged interest, some of which is given as compensation to the customers who lent their funds.

With the advancement of blockchain technology, this method has been adapted by creating decentralized financial systems (DeFi) without intermediaries. The role of banks as the central control of fund circulation is replaced by smart contract technology within the blockchain protocol.

Key Components of Yield Farming

Yield Farming, also known as liquidity mining, is a way to earn rewards or incentives by owning crypto assets. Essentially, you can earn more crypto with your existing crypto assets.

When engaging in yield farming, you become a liquidity provider (LP). Your crypto assets are deposited into a liquidity pool.

Liquidity pools are smart contracts that lock or contain funds from these lenders. With the crypto assets in the liquidity pool, they'll be utilized for various purposes on the platform, such as lending to other users in need of crypto assets. In return, you'll receive yields or returns after the smart contract missions are fulfilled.

Yield Farming is usually done using ERC-20 tokens on the Ethereum network. Furthermore, the interest earned by lenders is also in the form of ERC-20 tokens.

Each protocol implementing yield farming may have different distribution rules. However, liquidity providers will still receive rewards from the assets they lend in liquidity pools.

Typically, these funds are stored in stablecoins pegged to the USD, such as DAI, USDT, USDC, BUSD, and others. Some protocols usually mint their own tokens, which will be stored within the system. This can be seen in the Compound protocol, which has its token called COMP.

For example, if you have ETH and deposit it into the Compound protocol, your ETH will become cETH pegged to USD.

Other coins like DAI undergo similar processes and become cDAI. Moreover, these coins can move between protocols and of course, mint new coins representing them.

Furthermore, with the development and expansion of DeFi technology, these platforms or Decentralized Applications (dApps) will be able to support smart contract capabilities by moving between protocols.

How Crypto Yield Farming Works

Yield farming begins when liquidity providers (LPs) act as users who place their crypto assets into liquidity pools within the DeFi ecosystem. These LPs can be seen as crypto asset lending banks.

Users of the platform or borrowers of crypto assets will then be charged fees, which will be paid to the liquidity providers according to the share they contribute to the liquidity pools.

In addition to these fees, liquidity pools earn revenue through the distribution of new tokens entering the protocol. The more tokens that enter, the richer the liquidity pools become, which benefits all parties involved.

Yield Farming Return Profits

The profits from yield farming can come in the form of commissions (fees) paid by DeFi platforms. Fees can also come from other sources, depending on the agreements within the smart contract liquidity pool algorithm.

Some liquidity pools even reward you with tokens embedded in other liquidity pools. This mechanism can be either very complex or very simple.

So far, yield farming has only been running in the Ethereum ecosystem with returns in the form of ERC-20 tokens. However, applications running on this mechanism are possible to run on any blockchain as long as they can read smart contracts.

Yield farming widens the adoption of crypto and may even potentially replace liquidity methods in conventional financial services. This could happen because this method is more efficient since it doesn't require intermediary institutions to guarantee it.