What is yield farming?

To understand a yield-farming meaning, it’s important to grasp the concept of what a yield is first. Typically, a yield relates to returns on investments over a period of time. The yield can be measured as an interest earned or as a regular dividend paid back. 

Yield farming, however, refers specifically to cryptocurrency markets, and the return earned for lending or ‘staking’ cryptocurrency for a period of time. In a similar way to traditional banks that lend loans for interest, yield farmers lend their cryptocurrency that would otherwise be sitting in an account. In return, they are paid interest in the form of additional crypto assets. 

Yield farming explained

Yield farming, which can also be referred to as liquidity mining, involves locking your cryptocurrency in a ‘liquidity pool’ for various decentralised finance (DeFi) projects. These liquidity pools are smart contracts that hold a number of cryptocurrencies as staked by the individual owners.

For putting their crypto money in a liquidity pool, the owners are provided with returns. These returns, in the form of more crypto assets such as cryptocurrency tokens, can be further invested in other liquidity pools to generate more profits.

In a nutshell, yield farming offers an investment strategy for the passive growth of your cryptocurrency by simply locking it in a liquidity pool. However, please note, the broader yield-farming activities can range from staking to lending to borrowing using your crypto assets.

As a yield-farming example, cryptocurrency trading platform Crypto.com allows its users to stake its native CRO coins for various rewards such as interest, cashbacks and premium benefits. You can use their yield farming calculator to find out how much interest you can earn with an amount of tokens and the time you are willing to stake for.  

Benefits of yield farming

The strategy of yield farming benefits investors as they can earn by holding their cryptocurrency assets for a period of time. Yet the yield-farming activity also rewards the cryptocurrency platforms as it attracts more users searching for passive returns. 

The staked tokens could also gain more value as more investors would buy it for long-term returns. Therefore, yield farming can help in supporting the entire crypto ecosystem.

Risks involved

While yield farming may come across as an excellent opportunity to grow your cryptocurrency portfolio, it is not a risk-free game.

Considering yield farming makes use of secure contracts, which utilise technology to process transactions, it can attract hackers to find loopholes and exploit these liquidity pools to steal funds. Additionally, cryptocurrency markets remain extremely volatile. Any unfavourable price swings of a crypto can cause liquidity risk to its holders. 

You should also be aware of scams such as fake decentralised finance (DeFi) projects marketed as liquidity pools by developers to attract investments. These are referred to as ‘rug pulls’, which is why it’s important to conduct due diligence before yield-farming crypto.