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How To Build High-Performance DeFi Yield Farming?

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Yield farming is a method of generating more cryptocurrency with the existing cryptocurrency. It entails you lending your money to others using smart contracts, which are computer systems. You receive payments in the form of cryptocurrency in exchange for your services. Isn’t it easy enough? Well, not so fast.

Farmers who want to increase their yield can use highly complex tactics. To optimize their returns, they constantly switch their cryptos between various lending marketplaces. They’ll still keep the right yield farming methods a closely guarded secret. What is the reason for this? The more people who are aware of a plan, the less successful it is likely to be. Yield farming is the wild west of Decentralized Finance (DeFi), with farmers competing for a chance to farm the burgeoning market.

If you want to learn more? Continue reading to learn more.

Contents

Introduction

What is yield farming?

What started the yield farming boom?

What is Total Value Locked (TVL)?

How does yield farming work?

How are yield farming returns calculated?

What is collateralization in DeFi?

The risks of yield farming

Yield farming platforms and protocols

Compound Finance
MakerDAO
Synthetix
Aave
Uniswap
Curve Finance
Balancer
Yearn.finance

Closing thoughts

Introduction

In the blockchain space, the Decentralized Finance (DeFi) revolution has been at the forefront of progress. What distinguishes DeFi programmes from others? They are permissionless, which means that they can be interacted with by anybody (or something, like a smart contract) with an Internet connection and a backed wallet. Furthermore, they usually do not necessitate faith in any custodians or middlemen. To put it another way, they are untrustworthy. So, what new applications are made possible by these properties?

Yield farming is one of the latest concepts that has arisen. Using permissionless liquidity protocols, it’s a fresh way to gain benefits from cryptocurrency holdings. It enables everyone to gain passive income by using the Ethereum-based open ecosystem of “capital legos.” As a result, yield farming will have an effect on how investors hold their investments in the future. Why sit on your money while you can bring them to good use?

So, how does a high-yield farmer care for his or her crops? What kind of returns do they anticipate? And where do you begin if you want to work as a yield farmer? In this post, we’ll go through both of them.

What is yield farming?

Yield farming, also referred to as liquidity mining, is a way to generate rewards with cryptocurrency holdings. In simple terms, it means locking up cryptocurrencies and getting rewards.

In certain ways, yield farming and staking are similar. However, there is a great deal of complexity going on behind the scenes. It also collaborates with liquidity providers (LPs), who increased availability to liquidity pools.

What is a liquidity pool? It’s basically a smart contract that contains funds. In return for providing liquidity to the pool, LPs get a reward. That reward may come from fees generated by the underlying DeFi platform, or some other source.

Any liquidity pools payout in a variety of tokens. These payout tokens can then be invested into other liquidity pools to receive further prizes, and so on. You can see how very complicated tactics can evolve very easily. However, the fundamental concept is that a liquidity supplier invests funds into a liquidity pool in exchange for benefits.

Yield farming is normally conducted on Ethereum with ERC-20 tokens, and the prizes are usually just ERC-20 tokens. However, this could change in the future. What is the reason for this? Most of this operation is currently taking place in the Ethereum ecosystem.

On the other hand, cross-chain bridges and other similar technologies can one day allow DeFi applications to be blockchain agnostic. As a result, they may be able to operate on other blockchains that support smart contracts.

In order to achieve high yields, yield farmers will usually transfer their funds around a tonne between various protocols. As a result, DeFi platforms can provide additional financial incentives in order to entice more capital to their platform. Liquidity continues to draw more liquidity, just as it does on centralised markets.

What started the yield farming boom?

The arrival of the COMP token – the Compound Finance ecosystem’s governance token – may be to blame for the unexpected surge of interest in yield farming. Token holders who own governance tokens receive governance privileges. But how do you distribute these tokens if you want to make the network as decentralized as possible?

Distributing these governance tokens algorithmically, with liquidity bonuses, is a common way to kickstart a decentralised blockchain. Liquidity suppliers are enticed to “farm” the new token by supplying liquidity to the protocol.

Although the COMP didn’t invent yield farming, it did fuel the popularity of this form of token delivery model. Other DeFi ventures have also devised creative ways to draw liquidity to their environments.

What is Total Value Locked (TVL)?

So, what’s a good way to measure the overall health of the DeFi yield farming scene? Total Value Locked (TVL). It measures how much crypto is locked in DeFi lending and other types of money marketplaces.

TVL is, in several ways, the total liquidity in liquidity pools. It’s a valuable metric for gauging the overall health of the DeFi and yield farming markets. It’s also a good way to compare the “market share” of various DeFi protocols.

Defi Pulse is a good way to keep track of TVL. You will see which platforms in DeFi have the most ETH or other crypto assets locked up. This will give you a general understanding of where yield farming is right now.

Naturally, the more value is locked, the more yield farming may be going on. It’s worth noting that you can measure TVL in ETH, USD, or even BTC. Each will give you a different outlook for the state of the DeFi money markets.

How does yield farming work?

Yield farming is closely related to a model called automated market maker (AMM). It typically involves liquidity providers (LPs) and liquidity pools. Let’s see how it works.

Funds are deposited into a liquidity pool by liquidity suppliers. This pool is used to run a platform where users can lend, borrow, and trade tokens. Fees are charged for using these channels, and are then distributed to liquidity suppliers in proportion of their share of the liquidity pool. This is the base of an AMM’s activity.

However, since this is a modern technology, the implementations will be drastically different. There’s no question that new methods will emerge that will build on existing implementations.

Aside from fees, the issuance of a new token may be an additional reason to allocate funds to a liquidity pool. For eg, a token can only be available for purchase in limited quantities on the open market. It can be collected, on the other hand, by supplying liquidity to a given pool.

The propagation rules would be determined by the protocol’s special implementation. At the end, liquidity suppliers are compensated depending on the volume of liquidity they offer to the pool.

Stablecoins pegged to the US dollar are usually invested money, but this is not a prerequisite. DAI, USDT, USDC, BUSD, and other stablecoins are among the most commonly used in DeFi. Some protocols can create tokens to signify the coins you’ve deposited in the scheme. If you deposit DAI into Compound, for example, you’ll get cDAI, or Compound DAI. You will get cETH if you deposit ETH into Compound.

As you would expect, there are several levels of complexities to this. You could move your cDAI to a protocol that creates a third token to represent your cDAI and your DAI. The list goes on and on. These chains can become extremely complicated and difficult to obey.

How are yield farming returns calculated?

Typically, the estimated yield farming returns are calculated annualized. This estimates the returns that you could expect over the course of a year.

Some commonly used metrics are Annual Percentage Rate (APR) and Annual Percentage Yield (APY). The difference between them is that APR doesn’t take into account the effect of compounding, while APY does. Compounding, in this case, means directly reinvesting profits to generate more returns. However, be aware that APR and APY may be used interchangeably.

It’s also worth keeping in mind that these are only estimations and projections. Even short-terms rewards are quite difficult to estimate accurately. Why? Yield farming is a highly competitive and fast-paced market, and the rewards can fluctuate rapidly. If a yield farming strategy works for a while, many farmers will jump on the opportunity, and it may stop yielding high returns. 

As APR and APY come from the legacy markets, DeFi may need to find its own metrics for calculating returns. Due to the fast pace of DeFi, weekly or even daily estimated returns may make more sense.

What is collateralization in DeFi?

When you borrow money, you usually have to put up collateral to fund the debt. This actually serves as loan insurance. What is the significance of this? Depending on the protocol to which you’re sending money, you may need to keep an eye on the collateralization ratio.

If the value of the collateral falls below the protocol’s required threshold, it can be liquidated on the open market. What would you do to save the company from going bankrupt? You have the option of adding additional collateral.

To reiterate, each platform will have its own set of rules for this, i.e., their own required collateralization ratio. In addition, they commonly work with a concept called overcollateralization. This means that borrowers have to deposit more value than they want to borrow. Why? To reduce the risk of violent market crashes liquidating a large amount of collateral in the system.

Strategies

The aim of a yield farming strategy is to achieve a high return on investment. Lending, investing, providing money to liquidity pools, and staking LP tokens would be among the moves.

Lending and investing are two simple ways to earn APY on your money. For eg, a farmer might use a lending platform to supply a stable coin like DAI and start earning interest on their investment. They will then push it to the next stage of liquidity and leverage.

Some of the DeFi protocols will incentivize the farmer even more by allowing them to stake their liquidity provider or LP tokens representing their participation in a liquidity pool. It gets a bit more complicated here, and it is worth reading this more in-depth tutorial on staking to understand how it works.

Any of the tactics can be combined to give the farmer even more results. A policy, like most financial markets, will easily become outdated as protocols or incentives shift, so it’s critical to stay on top of it every day and adjust the strategies as needed.

The risks of yield farming

Farming for yield isn’t easy. The most profitable yield farming methods are very complex and can only be attempted by experienced farmers. Furthermore, yield farming is better suited to someone with a lot of money to invest (i.e., whales).

Yield farming isn’t as easy as it is, and you’ll most likely waste money if you don’t know what you’re doing. We just went over how to liquidate the collateral. So what other dangers can you be mindful of?

Smart contracts are an apparent challenge of yield farming. Many protocols are designed and developed by small teams with minimal budgets due to the nature of DeFi. This raises the possibility of smart contract glitches.

Vulnerabilities and glitches are found all the time, even in larger protocols that are audited by professional auditing companies. This will result in the depletion of consumer funds due to the transparent existence of blockchain. When locking your funds in a smart contract, you must keep this in mind.

Furthermore, one of DeFi’s greatest benefits is also one of the greatest dangers. It’s the concept of reusability. Let’s take a look at how it affects yield farming.

DeFi protocols, as previously said, are permissionless and can easily interact with one another. This ensures that each of the DeFi ecosystem’s building blocks is extremely dependent on the others. When we suggest that these programmes are composable, we mean that they will easily fit together.

Why is this a risk?  If even one of the building blocks fails to function properly, the entire ecosystem can suffer. This is one of the most significant threats to yield farmers and liquidity pools. You must trust not only the protocol into which you deposit your money, but also all others on which it is dependent.

Yield farming platforms and protocols

What are the methods for obtaining these yield farming rewards? There is no one-size-fits-all approach to yield farming. In reality, farming techniques for increasing yields will vary by the hour. There will be guidelines and threats specific to each network and approach. If you want to venture into yield farming, you’ll need to learn about decentralised liquidity protocols.

The fundamental concept has already been developed. You put money into a smart contract and get money back in exchange. However, there is a wide range of implementations. As a result, blindly depositing your hard-earned money and hoping for high returns is probably not a good option. You must be able to maintain leverage of the investment as a fundamental law of risk management.

Compound Finance

Compound is a computer-based money market that allows users to lend and borrow money. Anyone with an Ethereum wallet will contribute assets to Compound’s liquidity pool and start earning incentives right away. Based on supply and demand, the prices are set algorithmically.

One of the most important protocols in the yield farming ecosystem is compounding.

MakerDAO

Maker is a decentralised credit network that allows users to create DAI, a stablecoin that is algorithmically pegged to the US dollar. Anyone can create a Maker Vault and store collateral assets like ETH, BAT, USDC, or WBTC in it. They will use DAI to raise debt against the collateral they’ve secured. The stabilisation fee, which is set by MKR token holders, accrues interest over time on this debt.

Yield farmers may use Maker to mint DAI to use in yield farming strategies.

Synthetix

Synthetix is a protocol for creating synthetic assets. Anyone can use Synthetix Network Token (SNX) or Ethereum (ETH) as collateral and mint synthetic assets with it. What is a synthetic commodity, exactly? Almost all with a consistent price feed. This enables the Synthetix platform to accept nearly any financial commodity.

In the future, Synthetix will enable all kinds of assets to be used for yield farming. If you want to put your long-term gold bags to good use in your yield farming strategies? It’s possible that synthetic assets are the way to go.

Aave

Aave is a decentralised lending and investing protocol. Interest rates are adjusted based on existing market conditions using an algorithm. Lenders are compensated with “aTokens” in exchange for their funds. When you deposit these tokens, they automatically begin earning and compounding interest. Other specialised features, such as flash loans, are also available via Aave.

Yield farmers rely heavily on Aave as a decentralised lending and borrowing protocol.

Uniswap

Uniswap is a decentralised exchange (DEX) protocol that enables token exchanges with no confidence. To establish a demand, liquidity suppliers deposit the equivalent of two tokens. The liquidity pool will then be traded against by traders. Liquidity suppliers receive commissions on transactions that take place in their pool in exchange for providing liquidity.

Due to its frictionless architecture, Uniswap has been one of the most common sites for trustless token swaps. This is useful for high-yield cultivation techniques.

Curve Finance

Curve Finance is a decentralised trading protocol aimed at making stablecoin swaps more effective. Curve, unlike other related protocols such as Uniswap, enables users to make high-value stablecoin swaps with minimal slippage.

Curve pools are an important part of the infrastructure in the yield farming scene, as you would expect given the abundance of stablecoins.

Balancer

Uniswap and Curve are two liquidity protocols that are identical to Balancer. The only distinction is that custom token assignments in a liquidity pool are possible. Instead of the 50/50 allocation required by Uniswap, this enables liquidity providers to build custom Balancer pools. LPs collect commissions on trades that occur in their liquidity pool, much as they do with Uniswap.

Balancer is an important breakthrough for yield farming techniques because of the stability it provides when creating liquidity pools.

Yearn.finance

Yearn.finance is a shared network of lending aggregators that includes Aave, Compound, and other services. Its aim is to maximise token lending by identifying the most profitable lending services using an algorithm. Upon deposit, funds are transformed to yTokens, which are rebalanced on a regular basis to optimise benefit.

Farmers who want a protocol that selects the right solutions for them instantly will find Yearn.finance useful.

Closing thoughts

Yield farming, despite its infancy, has the potential to draw more users to DeFi protocols and increase consumer acceptance. It hasn’t yet matured into an efficient market, which means there are still plenty of ways to earn a high return on investment as opposed to conventional finance. It’s a complicated approach, so while we’ve included an outline here, you’ll need to read more in-depth guides before diving into the field of yield farming.

We’ve taken a look at the latest craze in the cryptocurrency space – yield farming.

What else will this financial decentralisation movement bring? It’s difficult to predict whether new applications based on these existing components will emerge in the future. Trustless liquidity protocols and other DeFi products, on the other hand, are unquestionably at the cutting edge of finance, cryptoeconomics, and computer science.

Without a question, DeFi money markets will contribute to the development of a more transparent and inclusive financial environment that is accessible to everyone with an Internet connection.

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