Why let your crypto sit idle in a wallet when it could be working for you? Yield farming is the rocket fuel of Decentralized Finance (DeFi).
In traditional finance, banks pay you 0.01% interest to hold your money, then lend it out at 5%. In DeFi, you are the bank. Yield farming allows you to earn rewards by locking up cryptocurrencies in liquidity pools.
How It Works: Liquidity Pools
Decentralized Exchanges (DEXs) like Uniswap rely on users to provide funds for trading. These users are called Liquidity Providers (LPs).
When you deposit a pair of assets (e.g., ETH and USDC) into a pool, you receive LP tokens representing your share. Every time a trader swaps ETH for USDC, they pay a fee. This fee goes directly to you and other LPs.
APR vs APY
It is crucial to understand the difference:
- APR (Annual Percentage Rate): Simple interest. If you earn 100% APR, and invest $1000, you have $2000 after a year.
- APY (Annual Percentage Yield): Compound interest. It assumes you reinvest your earnings regularly. 100% APR compounded daily is roughly 171% APY.
The Risks: Impermanent Loss
It sounds like free money, but there is a catch: Impermanent Loss (IL).
If the price of one asset in your pair skyrockets while the other stays stable, the pool automatically sells the winner to buy more of the loser to maintain balance. If you withdraw, you might end up with less total value than if you had simply held the assets in your wallet.
Pro Tip:
Always calculate your potential Impermanent Loss before entering a volatile pool. High yields (e.g., 500% APY) are often a trap to compensate for massive expected volatility.
Strategies for Beginners
- Stablecoin Pools: Pair USDC/USDT. No price divergence means almost zero impermanent loss. Yields are lower (5-15%) but safer.
- Blue Chip Pairs: BTC/ETH. These assets tend to move together, reducing IL risk.
- Single-Sided Staking: Some protocols allow you to stake just one asset (e.g., stake CAKE to earn CAKE). This eliminates IL risk entirely.