Breaking Down Yield Farming: What It Is and Where It’s Going - Identity Review - Identity Review | Global Tech Think Tank

Yield farming is the process of earning fixed or variable interest by investing crypto in a decentralized finance (DeFi) market. Put simply, it’s a process that allows crypto investors to lock up their holdings and gain rewards from it. Almost all yield farming uses ERC-20 tokens on Ethereum.

Yield farming is bolstered by smart contracts—a unique collection of code that resides at a specific address on the Ethereum blockchain. These contracts will allow parties to complete deals without having to know or trust each other. If the conditions embedded in the code aren’t met by each party, the contract will not be enforced.

A disclaimer—yield farming is most commonly pursued in large quantities. While possible, yield farming with $100 to $1000 will likely not result in profit due to high gas fees eating into returns.

Yield Farming Process Overview

The process begins with adding funds to a liquidity pool, a group of cryptocurrency funds bound by smart contracts featured on a decentralized marketplace. Once invested, a user becomes a provider in this marketplace and reaps rewards from their input.

The process is not as easy as investing crypto on platforms like Robinhood and Coinbase—users’ must lend their crypto assets before they can profit. These different rewards often come in the form of more tokens that users can reinvest into more liquidity pools.

There are two major players in yield farming: Compound and Aave. Combined, they have $1.1 billion of lending and $390M in borrowing.

Risks vs. Rewards

Yield farming boasts a high barrier to entry, requiring substantial capital to begin with. But that’s not the only threat to success—smart contracts are also issue-prone. If there are bugs in a bad contract, investments can be locked in, lost forever. The DeFi ecosystem is dependent on its building blocks— they’re permissionless and easily integrate with one another. If one falls, the entire system might follow.

Expansion Into Other Cryptos

Though yield farming is mainly limited to the Ethereum blockchain, cross-chain bridges—a decentralized coin exchange where users can swap cross-chain assets in liquidity pools—will soon close the gap between other cryptocurrencies. It’s the hope of many yield farmers that this process will expand to other major coins, like Bitcoin.

It’s hard to estimate where yield farming will take itself in the near future, but it’s here to stay. While intricate, this process is undoubtedly profitable to the savvy crypto community.

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