Clear DefinitionsYield Farming
1 min read
Pronunciation
[yeeld fahr-ming]
Analogy
Imagine you own various types of valuable seeds (different cryptocurrencies). Yield farming is like moving these seeds between different fertile fields (DeFi protocols) and using different farming techniques (lending, providing liquidity) to get the biggest harvest (earn the most crypto), sometimes even getting new, special seeds (governance tokens) as a bonus.
Definition
A decentralized finance (DeFi) strategy where participants deposit or lend their cryptocurrency assets to various protocols (like lending platforms or decentralized exchanges) to generate high returns or 'yield', often in the form of additional tokens and transaction fees.
Key Points Intro
Yield farming is a method to maximize returns on crypto assets within the DeFi ecosystem.
Key Points
Involves depositing or lending crypto assets to DeFi protocols.
Aims to generate high returns ('yield') on holdings.
Commonly involves providing liquidity to decentralized exchanges or lending pools.
Rewards often include transaction fees and newly issued governance tokens (liquidity mining).
Example
A user deposits ETH and DAI into the Uniswap V3 ETH/DAI liquidity pool. They receive LP tokens representing their share. They then stake these LP tokens in a separate 'farm' contract to earn UNI tokens (Uniswap's governance token) on top of the trading fees generated by the pool. This combination of fees and UNI rewards constitutes their yield.
Technical Deep Dive
Yield farming interacts with DeFi smart contracts. Participants provide assets to pools or vaults via these contracts. Returns can come from interest paid by borrowers (lending protocols), a share of trading fees (DEX liquidity pools), or newly minted tokens distributed as part of a liquidity mining program. Strategies can be complex, involving borrowing assets against deposited collateral to leverage yield opportunities across multiple protocols.
Security Warning
High risk activity due to potential smart contract vulnerabilities (protocol hacks), impermanent loss (for liquidity providers), liquidation risk (when borrowing), and extreme volatility in the price of reward tokens. Understanding the specific risks of each protocol used is critical.
