A Beginner’s Guide to Yield Farming
Yield Farming is a lot like real farming.
- It’s a lot harder than it looks
- What you get out of it is unpredictable
- While you can get started small, you only make a profit by going large
- It involves jumping through a lot of hoops
But let’s backtrack on this latest craze: what is it, how does it work, and why could we stay away from it and instead leave our Crypto in one place to earn a guaranteed rate of return which is reinvested every day?
What is Yield Farming?
Decentralised Finance (DeFi) reached the point in 2018 where they discovered the concept of interest (called “yield”, because it’s a more fitting term).
The idea is simple: you plant an investment, and it starts growing. It generates “yield”, which is paid either in the same token, a different token or even a combination of tokens. It’s common to be paid by a token specific to the provider you use. This token might even give you a say over how the provider operates. The rules and returns are different for each platform of course.
So, your mission is to take those yielded tokens to another platform, plant it there, watch it grow, harvest it, and so on.
True Yield Farming involves regularly ploughing your Crypto fields to unearth new opportunities or review existing ones.
Are you getting the optimum yield? Are you even on the right Blockchain?
Who’s doing Yield Farming?
Although Yield Farming has experienced explosive growth, it’s still mainly driven by Crypto enthusiasts and finance people who decided that the wild west area of Crypto was more to their liking. This team is left dreaming up complex and risky financial ideas with no one riding over the hill to set them straight. The term “high risk, high reward” was created for this environment.
There isn’t enough regulation in the sector to let banks join in, for instance. And the area is possibly too complex and risky for retail investors who would normally just stick their money in the bank.
But where do these yields come from?
With Decentralised Finance came Crypto lending and borrowing platforms (called “protocols”, because new sectors just love to create new jargon).
Obviously, these platforms need Crypto to lend out, and they need to reward people/companies for making Crypto available to their “liquidity pools” or “staking pools”.
These pools of resources allow platforms to function effectively. If a provider/protocol runs out of liquidity, that’s a real problem for them.
So the rewards for staking your Crypto are larger than the rewards you would get from lending your money to a bank (otherwise known as “saving”). And that means high “interest” on each side: lenders get more, and borrowers pay more.
Why on earth would they do that?
Well, mostly because the borrowers are convinced they can make a profit elsewhere.
There are thousands of Cryptocurrencies on exchanges and thousands more hiding on other Blockchains. There’s a ton of financial activities, coin launches, mining operations, etc (virtually all unregulated!). These are all potential moneymakers.
That explains why DeFi companies can offer yields much larger than the traditional finance sector, and it’s the same reason why Bitcoin is so volatile: people keep gambling with Crypto and this volatility can generate startling returns if you get lucky.
Sounds like I’m on the right side of that equation
It’s certainly a lot less risky to earn a smaller return by providing liquidity than borrowing money, yes: technically all you have to do is place your Crypto in place (A) to earn a return (B), then transfer it to (C) to earn (D).
By far the biggest place you’d do this is Uniswap, the second-biggest decentralised exchange, which hosts a bewildering number of dApps, tools and options. They also have an app themselves.
The Uniswap platform offers swaps between tokens (the exchange bit), and the ability to stake Crypto into liquidity pools for particular tokens: there are thousands of these tokens, generically called “ERC-20” tokens because they correspond to a particular technical standard.
As a liquidity provider, you earn a percentage of trading fees for every swap with that token, and you can earn significant interest, which varies dramatically according to market fluctuations and the token itself.
The people who deposit the most might also get a chance to govern the token rules too (by being given “governance tokens”): and as you’d probably expect, if a few people get a chance to make rules in their favour, they probably will (such as changing the yields).
So.. some doubts then?
A whole field of doubts, as you can tell.
1. Liquidity pools offer annual returns, yet some are only open for weeks and can open and close without notice.
One complaint about the behaviour of some liquidity pools is that there’s a lack of transparency about the returns, and liquidity pools come and go with very little scrutiny about their promises. It’s all unregulated, too.
2. Most tokens are small enough to be manipulated by a small number of rich people (“Whales”).
There is a huge difference between the amount of capital a regular person can invest (four figures, five figures if lucky), and the amount available to some of the players in Crypto, some of whom were lucky enough to have already made unimaginable amounts of money. Rich people can use tokens and liquidity pools like their own personal playthings. And guess who comes off worst?
3. ETH gas fees make moving small amounts and token swaps incredibly costly, at least on Ethereum.
This is the biggest reason why Yield Farming is only really a reasonable thing to do if you have five figures or more to invest.
Currently, prior to its ETH 2.0 upgrade, fees on the Ethereum Blockchain for doing pretty much anything are very high. Since those fees are more like flat fees, moving tokens around to take advantage of yield can wipe out any gains instantly. When the cost of converting $100 of USD Stablecoins to ETH works out at $33, you know something needs fixing.
4. The yields you’re moving about are much smaller than the amount you invested.
The whole point of Yield Farming is to get a yield in one place and invest it in another. But the yield you’re moving will be a lot smaller than the amount you invested, especially if you’re not leaving the investment in long. So high gas fees are a problem even if you’ve invested quite a lot.
Will ETH 2.0 collapse DeFi?
The ETH 2.0 upgrade should reduce gas fees to a fraction of their current level. But many of the yields in Yield Farming are dependent upon shares of transaction fees. At the moment, these are high. But where will the yield come from when the friction is removed?
An Alternative to Ethereum
A glimpse into the future is provided by a Blockchain that “forked” from Ethereum (i.e. it split off and started developing differently). That’s Binance Smart Chain, where ultra-low fees are a reality, yield farms such as “Autofarm” and “Pancake Bunny” still appear to be operating, and Crypto holders are moving around tokens much more than on Ethereum. Unlike Ethereum, the Binance Smart Chain is much less decentralised, which has advantages and disadvantages.
Advantages: more controlled.
Disadvantages: who by?
If you’re determined to yield farm with limited funds, then Binance’s “Smart Wallet” will introduce you to a staggering range of DeFi activities to thrill you and sap your wallet.
Where is this all going?
Regulators, in their painfully slow way, are paying closer and closer attention to the activities happening in Cryptocurrency, and that includes Decentralised Finance. While they can’t close up something like Ethereum, they could definitely take a chunk out of Binance Smart Chain if they wanted.
All of this lack of regulation also points to another thing: you have a market worth billions, but Yield Farming is not something that will ever achieve a critical mass with consumers: it’s complicated, scary and technical (and always will be).
That means that the potentially trillions of pounds from traditional finance just waiting in the wings are unlikely to pour into DeFi – the rules and the regulators would never allow it. Instead, those trillions will end up in regulator-friendly areas such as Security Tokens, derivatives, or Crypto-driven mutual funds. DeFi will always be a quick, dirty and anonymous alternative to traditional finance and KYC, but as the off-ramps to “real” currency are removed and anonymous exchange accounts are further restricted, doing anything with your theoretical “profits” becomes more and more difficult.
Yield Farming is actually a lot of work and a lot of risk if you’re aiming for optimal return.
This kind of Yield Farming on Ethereum isn’t mathematically even worth doing unless you’ve got a lot to invest because of gas fees that cancel out much of the yield.
Yield Farming on Binance Smart Chain with “Pancake Bunny” would probably give your financial advisor a heart attack once they’d stopped laughing about the name “Pancake Bunny”, and the coins are, if anything, even smaller and more questionable than the ERC-20 tokens you’d find on Uniswap.
So, how can I farm a yield without Yield Farming?
For newcomers to Crypto, maybe the best idea for a “set and forget” approach to Crypto is to invest in an interest-bearing Crypto account that either offers 7% APY on Stablecoins (that track the value of a real-world asset, such as the US Dollar) and 1% on long-established Crypto such as Ethereum and Bitcoin.
AQRU’s platform also offers interest calculated and added per day (though you can see it being added in real-time for fun). Because that interest is re-invested, this is a very easy source of Yield Farming: it happens automatically, and there are no extra fees for doing it.
Combine that with a friendly interface, a 10USDC initial welcome investment, KYC and excellent security, no fees for deposits and only a 100 Euro minimum deposit, and this is the sort of Yield Farming that would make even Old McBitcoin happy on his farm. Wait, did we get that right…?