DeFi Yield Farming Guide
Yield farming offers passive income but comes with unique volatility risks.
How Yield Farming Works
Liquidity Provision: Deposit token pairs to earn trading fees
Reward Tokens: Platforms reward LPs with native tokens
Yield Sources:
- Trading fees
- Incentive rewards
- Governance tokens
Volatility Risks
Impermanent Loss
When token prices diverge, LPs lose value vs holding.
Example:
- Provide ETH/USDC at $2000 ETH
- ETH goes to $3000
- LP position worth less than holding ETH
Smart Contract Risk
- Exploits
- Bugs
- Admin key risks
Best Practices
Stablecoin Pairs: Lower IL risk, stable yields
Blue Chip Protocols: Lower smart contract risk
Yield Diversification: Don't put everything in one pool
Monitor IL: Use tools to track impermanent loss