Beginner’s guide to yield farming in DeFi

The world of decentralized finance, or DeFi, is constantly evolving with emerging trends and buzzwords that make it very easy for a beginner to feel overwhelmed. From volatile price swings to new and sophisticated finance-related protocols and concepts, DeFi’s novelty requires participants to dig through new information and learn just as fast as the space is growing.

One of the buzzwords that you have likely come across in your quest to understand this emerging sector is “Yield Farming.”

To the uninitiated, the term yield farming (for example on AMMs such as Saddle Finance) might seem odd and unrelated to finance; however, the term refers to a reward scheme that is similar to how farmers plant their seeds and wait for a bountiful harvest later in the future.

In this beginner’s guide to yield farming, we will demonstrate how the concept works and why it is one of the main reasons the masses are drawn to DeFi platforms.

What is Yield Farming?

Yield Farming is an abstract concept in the world of decentralized finance that allows token holders to lock up their holdings over a given period in exchange for future rewards in the form of new tokens or extra tokens.

At its core, yield farming is any investment strategy that involves lending your tokens or staking your coins either in an exchange or on a dividend or interest-paying platform.

The concept is similar to earning interest on money in a savings account. Therefore, just as savings in your bank account accrue more interest the more time you allow the money to stay in the bank, your cryptocurrency yields are also set to increase the more you lock up your funds with a DeFi platform.

The difference, however, is that DeFi offers much greater interest in your money than what you can expect with traditional finance platforms. However, with greater rewards comes greater risks.

How does Yield Farming Work

Decentralized applications on the blockchain include various yield farming mechanisms into their applications to incentivize the participation of token holders and help grow the platform.

Instead of letting your tokens sit idle in your wallet, you can lock them up in a smart contract and get returns. Yield farming can be performed for various purposes. A platform might offer smart contracts that lock up your tokens over a given period to secure that platform’s network or offer liquidity to that platform’s decentralized exchange.

Is Yield Farming Similar to Liquidity Mining?

Yield farming and liquidity mining are pretty much the same things even though not all yield farming platforms are geared towards liquidity mining. Some are designed for staking and proof-of-stake (PoS) chains.

While liquidity mining specifically focuses on rewarding participants for providing liquidity, yield farming can produce rewards for participants based on a variety of reasons.

For instance, a user can lock up their tokens in a liquidity pool controlled by a smart contract that gives back liquidity pool tokens. The participant can then take those liquidity pool tokens and lock them up for a second time with a separate platform, thereby doubling the number of yields received.

Conclusion

Yield farming is one of the most innovative DeFi concepts to date. It can be used in liquidity mining platforms on decentralized exchanges, on lending protocols, or even DeFi insurance protocols, to mention a few.