Yield Farming is the buzz nowadays but people are still curious and in confusion about the basics of Yield Farming. This article will be a beginner’s guide to Yield Farming and Liquidity mining. This article will discuss Yield Farming definition.
Yield Farming definition
If you have been around Defi space for a while, you might have noticed that Yield Farming has gradually become one of the most trending topics. Yield farming, to put it another way, yield farming is an effective method for maximising the return on capital with various DeFi protocols.
The entire Yield Farming procedure entails multiple strategies in which yield farmers hop from one DeFi protocol to the next to improve their profits. One can never deny the fact that smart contracts on the Ethereum blockchain make it very simple for users to communicate and interact with various defi protocols and benefit from their properties and features.
Moreover, this enables yield farmers to devise new methods for multiplying their crypto wealth. When it comes to some of the yield farming techniques, Liquidity Mining is one of the most widely used methods by yield farmers.
Understanding Liquidity Mining
Before diving into Liquidity mining, let us briefly understand the concept of Liquidity Pools. Defi protocols have a lending pool. These pools are crucial since they store all the assets(liquidity) that the users can borrow. However, for the protocol to operate correctly, these pools must have an adequate supply of liquidity.
This is where lenders play a vital role in maintaining the availability of liquidity in the pools by adding their own assets to the pools. It can undoubtedly be said that maintaining the liquidity of the pool with your own crypto asset is a very significant step.
As a result, because investors (liquidity providers) play such an important role in the functioning of these protocols, they are compensated with tokens for their investments. Thus, in simpler terms, Liquidity Mining is the method of distributing tokens to significant users of a protocol.
Liquidity mining is, in the current scenario, one of the most successful mechanisms for yield farmers to gain additional interest and bonuses for crypto assets. Although Liquidity mining was first introduced to the world by Synthetix, it achieved its peak of glory when Compound introduced liquidity mining of COMP tokens, which provided users with higher rewards for using the protocol.
Let’s Talk about the RETURNS in Yield Farming
The returns in yield farming are calculated using two crucial metrics:
- APY – Annual Percentage Yield
- APR – Annual Percentage Return
Although both of the metrics appear quite similar, the significant difference between them is compounding.
While APR represents the annual simple interest rate, APY represents the rate after compounding.
The RISKS Involved
Yield farming undoubtedly offers a lot of high returns, but one can never deny the fact that it also comes with a lot of financial risks. Yield farming entails using several defi protocols, which often results in some really undesirable scenarios like high gas costs, market slippage, and impermanent losses.
Furthermore, smart contract code vulnerabilities and bugs can result in significant yield farming losses. For instance, on 26th October 2020, Harvest Finance suffered a $20 million loss in a liquidity hack.
However, one slightly troubling aspect of decentralised finance is that losses in DeFi are often irreversible. This is attributable to the immutability of blockchain technology. Therefore, it’s quite imperative to familiarise yourselves with the mechanisms of DeFi protocols before entering the world of Yield Farming.
Reach out to QuillHash
With an industry presence of years, QuillHash has delivered enterprise solutions across the globe. QuillHash with a team of experts is a leading blockchain development company providing various industry solutions including DeFi enterprise, If you need any assistance in the smart contract audit, feel free to reach out to our experts here!
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Source: https://blog.quillhash.com/2021/03/22/basics-of-yield-farming-liquidity-mining-yield-farming-definition/
