Yield farming: A strategy to multiply returns on your money

The goal of all investments is to provide returns or profits in excess of the initial investment made in acquiring the financial product. Having a savings bank account with traditional finance institutions provide you with protection and a meagre profit on your investment. Traditional financial institutions in the US on average pay depositors about 0.06% Annualized percentage Yield (APY).

APY is the annual profit earned by individuals and depositors who provide liquidity in the form of deposits to financial institutions.

Do you know you can earn in excess of 200% APY on your money? Yes, between 200% -1000% APY. and you don't even have to wait a year to earn such interest. You accrue them on a daily basis.

According to Defi-pulse, about $106 billion is the amount funds locked up in investments in Decentralized finance as at 24th November, 2021.

However, such investments come with high risks, you might have heard of the financial jargon, 'The higher the risk, the higher the reward', This is true, and its not for the faint hearted. This strategy is known as Yield farming OR Liquidity mining and it is applied in Decentralized finance also know as Defi.

Summary of blog post

What is Yield farming
Use cases of yield farming
Finding profitable yield farms
Is Yield farming safe?
What are the risks in yield farming?

What is Yield farming

With yield farming, it provides a means of earning returns or interest on your cryptocurrency, just as how you earn interest on the money in your savings account. Yield farming involves locking up your cryptocurrency in a smart contract, called "staking," for a period of time in exchange for interest or other rewards. Smart contracts mimic the performance of the intermediary role of centralized financial institutions with self-executing lines of code built into a blockchain.

In traditional banking or centralized finance (Cefi), when a customer deposits funds in his bank account, a record is made in the banks record to acknowledge the deposit of funds by the customer, the bank, then lends out the funds to other customers who want the use of the funds plus interest.
The same concept is what Yield farming is about, except that instead of the bank choosing who the funds are lent out to based on their internal policies and discretions, with yield farming, the funds are deposited in a pool managed by smart contracts, and generates very high returns in excess of the centralized finance offerings.
Aside from the interest you earn from your temporarily staked funds in return for profit, you can also use your locked up funds as a collateral to borrow more money to use for other investment opportunities.
"Eating your cake and still having access to your cake".

Video instructions on how to Yield farm

Use cases of yield farming

Crypto borrowers have a lot of options in the use the borrowed funds. The following are some ways that borrowers use the funds.

Yield farming: You can invest the money in other yield farms paying higher returns than the interest being charged by the lending pools for giving out the funds.

Intraday trading or Day Trading: You can also use the borrowed funds to day trade, day trading is the profiting from the volatility in asset pricing pairs on a daily basis, It is done by buying a currency when the price is low and selling it at higher price based on market volatility predictions.

Hodling: Holdling is a long term strategy used to profit from asset pricing. Suppose an investor purchased Ethereum when it was selling at $200, now in 2021, with the price hovering around $4,000. an investor would have made profits of about $3,800.

Arbitrage: Sometimes, arbitrage opportunities become available across markets or exchanges, the difference in pricing across these markets presents arbitrage opportunities by buying low on one exchange and selling high on another, while keeping in mind the transaction costs.

Finding profitable yield farms

With its risky nature, comes its profitable potential - otherwise no one would engage in it. Coin MarketCap provides a a list of yield-farming rankings with their yearly and daily APY's. Some pools can offer double digit yearly APY, and some with those thousand-percentage point APYs.

• Aave: is a liquidity protocol that lets users lend and borrow crypto. Depositors (lenders) earn interest on deposits in the form of AAVE tokens (aTokens), a derivative. Cryptos can also be borrowed for stable and variable interest rates. Participation requires no KYC (Know -Your-Customer) for users.

Lending and borrowing are automatically controlled by smart contracts which eliminates the need for manual matching of lenders and borrowers. For every single DAI token deposited on Aave, the depositor would receive an equivalent aDAI tokens. The aDAI token would also earn interest and could either be exchanged for the original asset on Aave, or traded on any other Defi yield earning platforms.

• Curve Finance: is a liquidity pool on Ethereum that uses a market-making algorithm to let users exchange stable coins. Pools using stable coins can be safer since their value is pegged to another medium of exchange. Stable coins are crypto tokens which have its price pegged to an underlying asset, such as the US dollar.

• Compound finance: allows lenders and borrowers to interact directly with the protocol to earn or pay a floating interest rate. The protocol provides a pool of Ethereum (ETH)-based assets and tokens, lends them out to users using a smart contract at an automatically-adjusted rate. Supplied assets are interest bearing derivative tokens known as cTokens, and issued at 1:1 ratio.

• Harvest finance: is a yield farm aggregator available on Ethereum, Binance Smart Chain, and Polygon. The platform helps users to maximize the returns on their assets by depositing in various projects across the Defi ecosystem, Harvest finance provides a convenient way to harvest yield opportunities without moving funds around in Defi, hence it by saves time and gas costs.

• Uniswap: is a decentralized exchange on the Ethereum Block chain where liquidity providers provide liquidity by staking their digital assets in a pool pair in a 50/50 ratio. In exchange, you earn a portion of the transaction fees plus UNI governance tokens. The native token on Uniswap is Ethereum (ETH).

• Pancake swap: is a fork of Uniswap, meaning, it copies the exact functionalities and behavior of Uniswap, However, Pancake swap exists on the Binance Smart Chain (BSC), the native token to BSC is BNB.

Other yield farms exist, but these are the best farms available.

Is Yield farming safe?

Deposits with traditional centralized financial institutions in most jurisdictions are insured by their Federal Deposit Insurance Corporations, while Defi platforms generally don't provide any means by which to recover lost money. In a traditional finance system, a consumer can file a complaint with the Consumer Financial Protection Bureau, but no such recourse exists if you become a victim of a fraudulent Defi transaction.

What are the risks in yield farming?

There's risk in almost every activity, risk is a chance of loss, and like all activities, there presents an element of risk, some higher than others. When choosing a yield farming pool, It's best to select pools that minimize the risk by looking into the team behind the application, its transparency and security audits. Below are some risks that can present itself in yield farming.

Volatility: Volatility is the degree to which an investment's price fluctuates. A volatile investment is one that experiences a lot of price movement in a short period of time. The price of your tokens could crash or surge while they're locked up.

Fraud: Crypto depositors, also known as yield farmers sometimes invest in replica tokens and projects that make off with all of their investments. Fraud and misappropriation account for the vast majority of the $1.9 billion in crypto crimes in 2020, according to a report by CipherTrace.
Also, rug pulls do occur, and they are a type of exit scam where a cryptocurrency developer gathers investor funds for a project, abandons the project without returning invested funds. Nearly 99% of the major fraud that occurred during the second half of the year was due to rug pulls.

Smart contract risk: The smart contracts used in yield farming can have bugs or be susceptible to hacking, putting your cryptocurrency at risk. Sometimes, bugs are found after smart contracts have been subjected to auditing. Due to the ‘immutable’ nature of blockchain transactions, if pause instructions are not put in the smart contract, changes can't be made to a block and this can lead to significant loss of capital. Better code vetting and third-party audits can improve security of smart contracts.

Excessive fees: To mitigate abusive or excessive use of the computational resources on the network, computational resources required to interact with smart contracts are metered. This allows users to outbid each other by attaching higher transaction fees in an effort get priority of their transaction for inclusion in the next block. In scenarios where network congestion coincides with a periods of price volatility, it is possible transaction fees might become excessive

Impermanent loss: The value of your cryptocurrency could rise or fall while it is staked, creating temporarily unrealized gains or losses. These gains or losses become permanent when you withdraw your tokens, and may result in you having been better off if you'd kept your coins available to trade if the loss is greater than the interest you earned.

Regulatory risk: There are still many regulatory questions around cryptocurrency. The SEC has stated that some digital assets are securities and thus fall under its jurisdiction, allowing it to regulate them. However, most cryptocurrency lack regulation and that means there is no protection for users who have an issue with their investment.

Final words

Multiplying your returns is possible, and there are strategies that you can implement to do this. Yield farming provides an opportunity for diversification of earnings. To participate in yield farming, one has to make sure he/she understands what the strategy is about, how to capitalize on it and how to exit when the time is needed. High risks come with higher rewards, investors in this field are to choose carefully and not invest all the funds in this space. When choosing Yield farms, make sure you choose yield farms that have credibility with little risk issues. One of such is Aave.

Its risky, but if you have to do it, choose your farms wisely.