Farming Overview

YFDAI Yield Farming:

The casual crypto observer who only steps into the market when activity heats up might be starting to get faint vibes that something is happening right now. Yield Farming is the source of those vibes. In order to understand how Yield Farming works you need to have a basic understanding of DeFi in general. DeFi applications such as YFDAI have revolutionized traditional financial services previously only offered by banks in the legacy economy. YFDAI and other Yield Farming and Lending protocols use permissionless and trustless apps and smart contracts that tap into liquidity protocols to offer a passive income on crypto assets. DeFi is establishing a more open and accessible financial system for anyone with an internet connection. Immature and experimental though it may be, the technology’s implications are staggering. On the normal web, you can’t buy a toaster without giving the site owner enough data to learn your whole life story. In DeFi, you can borrow money without anyone even asking for your name. DeFi applications don’t worry about trusting you because they have the collateral you put up to back the debt. So, what’s the point of borrowing for people who already have the money you might be wondering? Most people do it for some kind of trade. The most obvious example, to short a token (the act of profiting if its price falls). It’s also good for someone who wants to hold onto a token but still play the market by Yield Farming for a greater interest rate than what they are paying on the loan.

Liquidity Mining/Yield Farming Basics:

Yield Farming is similar to Staking crypto currencies since you get rewarded for locking up your tokens in both protocols.[1] There are as many different strategies to engage in yield farming as there are platforms that offer the service. Typically, it works with Liquidity Providers (LPs) that add funds to liquidity pools, like the ones on Uniswap, a decentralized exchange (DEX). Fees generated by the underlying DeFi platform and other sources such as token launch fees, staking and unlocking fees provide the funds to sustain the rewards to farmers. [2]

These liquidity pools provide a marketplace where users can lend, borrow, or exchange tokens. Usage of these services incur fees which are paid out to liquidity providers according to their pro-rata share of the total pool. This is the foundation of how Automated Market Making (AMM) works.

Yield Farmers move their funds around often between different protocols in search of high yields. DeFi platforms may also provide other economic incentives to attract more capital to their platform since liquidity attracts more liquidity just like on centralized exchanges. The Farming part comes from providing the liquidity to the new tokens on those decentralized exchanges. The Total Value Locked (TVL) measures how much crypto is locked in DeFi lending and other money marketplaces. Defi Pulse tracks TVL. Checking which platforms have the highest amount of ETH or other Crypto locked in DeFi can give a general understanding of the current state of Yield Farming on the blockchain.

Another incentive to add funds to a liquidity pool is to accumulate new tokens. The liquidity provider (Yield Farmer) could be rewarded by distribution of the new token to a specific pool in addition to the interest being earned.

The funds deposited are commonly stable coins like DAI, USDT, BUSD, USDC etc. These coins are pegged to the US dollar.

Yield Farming returns are usually estimated on an annual basis in the form of Annual Percentage Rate (APR) or Annual Percentage Yield (APY). APY includes the value of compounding while APR does not.

Yield Farming returns can fluctuate fast and often, which is why Farmers have many different strategies to maximize yield that include moving from one protocol to another chasing the highest returns.

Naturally in any high reward scenario there are going to be high risks to Yield Farming. One of the biggest risks with the crypto market is its volatility and market crashes. Depending on what protocol you are depositing your funds to, there will be rules you have to be aware of and comply with such as collateralization ratios. If your collateral falls below the threshold required by the protocol you may get a margin call where your collateral may be liquidated if you don’t deposit more collateral. Overcollateralization is a way to prevent the margin calls from wiping out your deposit. Depositing 200% or more of what you are borrowing will protect your deposit from being liquidated in a sudden market crash.

Other risks of Yield Farming include defects in smart contracts known as bugs. Often many protocols are built and developed by small teams with limited budgets who don’t get their code audited. When you Yield Farm on one of these platforms you could lose all your funds due to the immutability of the blockchain. These platforms may pay the highest yields, but they also have the highest risks. Bugs are found all the time even where the developers get the code audited.

One of the biggest advantages of DeFi is also one of its greatest risks. This is the idea of composability. Since DeFi protocols are permissionless and can fit together like blocks of Lego they are composable and can easily work together. The problem is if one of these blocks fails, it could bring down the whole system. So not only do you have to trust the protocol you deposit funds into, but also all the others that it may be reliant upon.

Yield farming isn’t simple. The most profitable Yield Farming strategies are very complex and not recommended for the novice user. Also Yield Farming is more suitable to the proverbial crypto whales — those who have large sums of capital to deploy. If you don’t understand what you are doing chances are good that you may lose money. Yield Farmers are extremely creative. They find ways to ‘stack’ yields and even earn multiple governance tokens at once.

That being said let’s take a look at some of the more popular Yield Farming protocols out there:

YEARN FINANCE: Aims to optimize token lending by algorithmically finding the most profitable lending services. It is composed of a decentralized ecosystem of aggregators for lending services such as Compound and Aave. Funds are converted to yTokens upon depositing that periodically rebalance to maximize profit. This strategy is best suited for those who want a protocol that automatically chooses the best strategies for them.

UNISWAP: Uniswap is a robot on the internet that is always willing to buy and it’s also always willing to sell any cryptocurrency for which it has a market. Liquidity providers deposit an equivalent amount of value of two tokens to create a market on this decentralized exchange (DEX) that provides for trustless token swaps. One of the tokens is ETH the other is whatever token you are providing the liquidity for. Uniswap can make it look like it is making a direct trade for any two tokens, which makes it easy for users, but it’s all built around pools of two tokens. And all these market pairs work better with bigger pools. Uniswap is one of the most popular platforms for trustless token swaps, but there are others like Sushi swap and YFDAI’s soon to be released SafeSwap. If the team behind the token on Uniswap decides to do a “rug pull” and remove all ETH and Tokens from the smart contract, liquidity providers could be impacted by the theft. With SafeSwap that won’t be possible because the tokens will be locked.

CURVE FINANCE: Designed for efficient stable coin swaps with a similar protocol to Uniswap, the Curve DEX allows users to make high value stable coin swaps with low slippage.

AAVE: Another decentralized lending and borrowing protocol heavily used by Yield Farmers, Aave lenders get “aTokens” in return for their funds. These tokens earn interest which compounds. Aave also allows for more complex functions like Flash Loans. Interest is adjusted algorithmically based on current market conditions.

Put Simply, DeFi is all the things that let you play with money, and the only identification you need is a crypto wallet. Liquidity is the chief concern of all these different products. That is: How much money do they have locked in their smart contracts? The product experience gets much better if you have lots of liquidity. The risk is greater as there’s no Federal Deposit Insurance Corporation (FDIC) protecting these funds. Insurance is available on many platforms to mitigate losses; this is something that YFDAI will also be releasing very soon. Yield Farming is so hot right now because it is turbo charged by Liquidity Mining where a Yield Farmer gets a new token as well as the usual return (that’s the mining part) in exchange for his providing liquidity. The whole DeFi sector is still in its infancy, and it is sure to continue to be a major sector in the industry considering the rewards that can be made by becoming a Yield Farmer.

We hope that this overview to farming has been helpful and will prepare you for the release of the first YFDAI farming pool that will be released late September/early October. We would like to take this opportunity to thank Richard V from our community who has written this piece on our behalf.

Prior to release we will provide a further update giving full details of the terms, and a guide on how to farm YFDAI.

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[1] Yield Farming involves mostly ERC20 tokens on Ethereum with rewards in ERC20 tokens. This could change in the future.

[2] Uniswap for example charges .3% transaction fee on every token sale.

YFDAI is a community centric, innovative DeFi project developed by the people, for the people.

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