Yield farming is the latest buzzword around the DeFi (decentralized finance) world. The basic concept of yield farming involves generating more returns with your existing crypto: yield farmers lend out their crypto assets and earn more crypto as reward. Since DeFi is permissionless, anyone from anywhere can join the network – all they’d require is a functional internet connection. This also means anyone can try out yield farming strategies to lend out their crypto for some passive income; therefore, yield farming could potentially turn the currently most practiced way of crypto trading- ‘HODL’ing assets and not using them- on its head.
There are several tried and trusted yield farming strategies out there that traders employ for increased profits, but before we get into those, let’s first find out the basics of yield farming, shall we?
Yield Farming: the Basics
Yield farming has been around for quite some time now, but the sudden hype surrounding the protocol has to be credited to the launch of the COMP token – the governance token of the Compound Finance exchange. Governance tokens, in case you weren’t aware, give token holders the right to vote in the governance polls of an exchange platform.
Compound used the token distribution protocol to their benefit, while simultaneously giving yield farming’s popularity the much-needed propulsion. Compound offered users an opportunity to earn rewards if they ‘farmed’ COMP by funding any of their liquidity pools.
The main players in yield farming are called the LPs, or the liquidity providers. These are the people who put their own crypto assets into smart contracts, also known as liquidity pools and generate returns. The liquidity pools gather funds from LPs, and their coding ensures the LPs earn yields out of their investments. The yields are usually a share of the trading fees the DeFi exchange hosting a liquidity pool generates.
Liquidity pools are essentially marketplaces where users can lend out, exchange, and borrow cryptocurrency. This benefits the LPs because proportionate to their share in the pool’s funds, a fraction of the overall trading fees the exchange platforms earn goes to them. Plus, at some exchanges, funding a liquidity pool means LPs get to earn that platform’s token, which can’t be bought in the open market.
The token distribution rules are as varied as the sheer number of exchange platforms out there. Some exchanges give out minted tokens to LPs that represent their deposited assets. For example, if you deposit the stablecoin USDC into a Compound pool, you’d get cUSDC in return. Some liquidity pools even pay the rewards in the form of several tokens, which can then be deposited to other pools, and the chain goes on.
The basic strategy of a yield farmer is moving their assets around between different liquidity pools, chasing after the one that would potentially provide the best interests. Yield farming is also occasionally referred to as liquidity mining.
Before we take a look at some popular yield farming strategies, first let’s find out about some networks that have been supplying traders with good returns in recent times.
Yield Farming Networks:
- Synthetix: This one is a synthetic asset protocol. An user can store Synthetix’s token SNX or ETH as collateral on Synthetix, and have synthetic assets minted against it. Anything with a dependable price feed can be a synthetic asset, so Synthetix allows a wide range of assets to be used for yield farming.
- Balancer: On Balancer, LPs can create customized pools instead of abiding by the allocation ratios many other platforms enforce. The flexible aspect of Balancer has made it popular among yield farmers.
- Curve.Finance: Curve.Finance is mostly used for stablecoin exchanges at low fees. Stablecoins are one of the most flexible and beneficial assets a yield farmer can hold, so Curve.Finance is a fairly popular yield farming network.
- Compound Finance: The very same network that brought yield farming back in fashion, any user with an Ethereum wallet can act as a liquidity provider on Compound and earn rewards that begin compounding instantly.
Popular Yield Farming Strategies:
Most traders use the APR (Annual Percentage Rate) or the APY (Annual Percentage Yield) to figure out what sort of returns a particular liquidity pool on an exchange platform would get them. However, yield farming is not as simple as just investing your capital into the liquidity pool with the highest projected returns you could find. Before deciding on a suitable and profitable yield farming strategy, first it’s important to realize what exactly makes for a good strategy.
For example, as a yield farmer, you should have faith in a particular platform’s token before you invest in a pool on that platform. A strategy that supports the particular trading network you’re farming on while bringing in profits, is bound to be an advantageous one both for you and the protocol.
Without any further ado, let’s take a look at some yield farming strategies many traders have used for sizable returns.
1. The sETH/ETH Balancer Pool Strategy:
The Strategy: Say you hold 100 ETH. You stake 50 of them on Synthetix and get sETH in return, so now you have 50 ETH and 50 sETH. All you have to do is store them both inside the Balancer ETH/sETH pool, and you get BAL tokens in return.
- The ETH/sETH pool is one of the best performing pools on Balancer, with an APR of around 30% as of July 2020.
- Even though the returns on Balancer are going down with time, they are still generally better than the returns on most of its contemporaries.
- You’re farming BAL tokens, which makes the platform stronger, and gives you the power to vote in future governance decisions.
- This strategy makes holding ETH even more beneficial than it already is.
2. The sUSD Curve Pool Strategy:
The Strategy: When you store your USD on Synthetix, you can have sUSD or Synthetic USD minted against it. Now when you deposit the acquired sUSD on the Curve sUSD pool, you get Curve tokens back in return, which you can then stake back on Synthetix.
- Synthetix and Curve.fi are both sturdy networks you can put your faith in.
- Both the Synthetix and Curve ecosystems provide great token appreciations to their LPs.
- This strategy is useful to Synthetix because you’d be providing sUSD liquidity to the Synthetix network, and thus doing your part in making SNX a valuable token to hold.
- The transaction costs you have to bear while converting USD into sUSD are practically insubstantial.
- Curve is currently going strong as an exchange platform, therefore Curve tokens might prove to be of great worth in the near future.
3. The cUSDC-cUSDT-COMP Balancer Pool Strategy:
The Strategy: This pool has an allocation ratio so that you’d have to supply 49% cUSDC, 49% cUSDT, and 2% COMP. So to employ this strategy, first you take your USDT and USDC, stake them on Compound and get cUSDT and cUSDC respectively in return. Now you invest them with COMP tokens in the Balancer cUSDC-cUSDT-COMP pool as per the required proportions and get BAL tokens as reward.
- Both the Balancer and Compound networks are highly proficient and the returns are great.
- The usual smart contract risks you run while trading on a DeFi platform are minimal.
- BAL tokens are one of the most profitable DeFi tokens you can hold right now.
- Your yield farming helps both Balancer and Compound grow stronger as exchange networks, which ultimately increases your returns.
And there you have it – some of the most profitable yield farming strategies you can utilize for increased returns. It’s true that yield farming, just like the rest of the DeFi ecosystem, is still in the development stage. However, with the many DeFi networks coming up with increasingly innovative farming protocols and newer economic incentives to attract liquidity, the journey of yield farming so far has been very fascinating indeed, albeit volatile. And as for what happens ahead, we’ll just have to wait and see for ourselves, won’t we?