Crypto farms: what’s the hype all about?
Farming offers an accessible alternative to mining as a way for users to earn cryptocurrency rewards. It enables investors to maximise returns on their cryptocurrencies by paying a form of interest on the coins they buy and hold, rather than trade.
How does crypto farming work? And how does it differ from staking and other forms of mining?
Read on for our introductory guide to farming in cryptocurrency.
Crypto farms offer high yield for liquidity
What is a crypto farm? Cryptocurrency farming, also known as yield farming, involves users lending their cryptocurrency to an exchange in farms, or pools, to provide liquidity for trading in exchange for incentives. New DEXs and coins often need this liquidity to have sufficient coins in circulation to get up and running.
Yield farmers deposit their cryptocurrency coins in a liquidity pool through a decentralised app (dApp). Smart contracts running on the blockchain facilitate lending the coins to other users for trading and borrowing.
By locking up their coins in this way, investors earn interest in the form of additional coins. If the price of those coins rises, the investor receives higher returns. Investors receive returns on their funds in terms of an annual percentage yield (APY). Apps reward yield farmers with a portion of their transaction fees or other funds. They can pay out rewards in the form of the same coins the farmer deposits, their own governance tokens, stablecoins or other coins.
Yield farmers can deposit single assets or provide liquidity pairs. For example, on an automated market maker (AMM) platform like PancakeSwap, SushiSwap or UniSwap, yield farmers provide liquidity in a pool by depositing two coins for an exchange pair. One of the coins is typically the native blockchain token or a stablecoin such as USDC. On PancakeSwap, which runs on the Binance blockchain, coins are primarily paired with the Binance token BNB or the BUSD stablecoin. (Note that the Binance platform was banned in the UK earlier this year). On Uniswap, which runs on the Ethereum blockchain, coins are mainly paired with ETH or the USDC, USDT and DAI stablecoins.
As a reward, yield farmers receive a share of the transaction fees that users pay to swap coins. The amount they receive is based on the percentage of the pool they contribute – the more they lend, the higher the return.
Yield farmers can lend their coins to the liquidity pool for a few days or as long as a year. They typically pay transaction fees for joining or leaving the pool.
APYs for different liquidity pools are highly competitive and change frequently, so yield farmers looking for the highest yields often switch between pools to maximise their returns.
While returns can be high, farming is risky – coins users receive as rewards can lose their value. The highest returns are typically available for newer cryptocurrencies, which can be “rug pulls”, scams where developers fraudulently hype up a coin price and sell off their tokens to withdraw all the funds.
Another risk of yield farming ‘impermanent loss’. In liquidity pools where investors deposit pairs, if one of the coins is a stablecoin and the other soars in value, the AMM adjusts the ratio of the two coins to keep the value constant. This results in a disconnect between the value of the coins compared with how many were deposited.
If the investor removes their coins from the pool, the impermanent loss becomes a permanent loss that may not be covered by the fees they have received as a reward. In that case, they would have made a higher return if they had not deposited their coins in the pool.
Yield farming vs staking
The term “yield farming” is sometimes used interchangeably with “staking”, but there are key differences between crypto farming vs staking.
Staking works as part of crypto mining farms and DeFi protocols. In Proof-of-Stake (PoS) blockchain consensus algorithms, users set up a validator node and join a PoS network to become a validator. Validators lock up their cryptocurrency coins to verify blockchain transactions. They receive rewards for reaching consensus, which enables the network to generate each new block.
Unlike yield farming, staking is a form of cryptocurrency mining that’s used to secure a blockchain network rather than providing liquidity. The more validators that stake their coins, the more decentralised and secure a blockchain becomes.
Ethereum, for example, has been working on moving from the Proof-of-Work (PoW) mining algorithm to PoS. PoW was the main way to mine cryptocurrencies and earn coins.
The Bitcoin blockchain is based on PoW, which uses computing power to solve complex cryptographic calculations to verify transactions and create new blocks, rewarding miners with cryptocurrency coins. Using staking rather than computing power in a coin mining farm requires far less energy, making it an energy-efficient alternative to PoW. The massive computing power required to mine bitcoin has made it relatively inaccessible for most investors, with large mining farms using specialised computer processors now accounting for most new bitcoin creation.
Protocols such as Polkadot use Nominated Proof-of-Stake (NPoS) consensus to allow holders of their native coin to stake them and nominate validator nodes in return for APY. Some protocols require users to stake their coins to participate in governance and vote on development decisions, demonstrating their commitment to the success of the project.
Centralised cryptocurrency platforms such as Coinbase, FTX, BlockFi and Nexo allow users to stake their cryptocurrencies, paying them interest in exchange for lending out their deposits. This works in a similar way to how traditional banks pay interest to lend out customers’ savings. Exchanges handle the validation process on behalf of investors, freeing them up to stake multiple cryptocurrencies from a single platform, rather than across multiple platforms or DEXs.
Unlike with yield farming, in staking investors agree to lock up their coins for a fixed period and are often required to stake a minimum number of coins. Staking rewards tend to be fixed APY rates of around 5%, far lower than typical yield farming APYs.
Depositing liquidity pairs on DEXs for yield farming can be challenging for investors new to cryptocurrencies. It also requires ongoing research to keep track of the most competitive rates while avoiding risky new coins that turn out to be scams. Staking provides lower returns, but is more straightforward for investors, who can lock up their funds for extended periods.
Whether you choose yield farming or staking should depend on your experience in using dApps, your risk tolerance, and the amount of time you want to spend on researching farms and APYs.
Yield farming – locks up coins to provide liquidity for decentralised cryptocurrency exchanges and new cryptocurrency launches in exchange for rewards in fees and coins.
Staking – locks up coins to facilitate cryptocurrency mining or enabling decentralised finance services such as lending or margin trading.
Proof-of-Stake (PoS) – a form of cryptocurrency mining that locks up coins to provide validation for blockchain consensus algorithms, verifying transactions in exchange for reward fees per block
Proof-of-Work (PoW) – a form of cryptocurrency mining that uses computing power to solve complex cryptographic problems to validate blockchain consensus algorithms, verifying transactions in exchange for reward fees per block
Is crypto farming illegal?
Cryptocurrency farming is not in itself illegal in most countries. A notable exception is China, which has banned cryptocurrency mining and virtual currencies.
However, as Proof-of-Work (PoW) mining is highly energy intensive, some miners in various parts of the world have set up farms with computers using illegal connections to the electricity grid. Yield farming provides liquidity rather than using computing power to mine coins, so it does not consume large amounts of electricity.
What is the biggest crypto mining farm?
The biggest cryptocurrency mining farm was previously in Dalian, China, mining 750 bitcoin each month and accounting for 3% of all bitcoin mining, according to data centre firm Sunbird. Since China banned cryptocurrency mining, the US has become the world’s biggest crypto mining country.
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