What is yield farming?
It is a method of maximizing the rate of return on capital by leveraging different protocols. You can deposit UBN in a pool with other UBN holders to pursue investment gains and earn interest by lending the pooled UBN.
The aim of yield farming is to get the highest yield which can be accomplished by switching between multiple different strategies. The most profitable strategies usually involve at least a few DeFi protocols such as Compound, Uniswap, Synthetix etc. Yield farming may entail moving funds between different protocols or swapping coins to other ones that are currently generating more yield. This procedure is sometimes called crop rotation.
The rate of return from yield farming strategies is calculated using Annualized Percentage Yield (APY). APY compares rates of return across different products. It’s a normalized representation of an interest rate based on a compounding period of one year. Traditional saving accounts (saving your cash in banks) usually have an APY of 0.1 percent and anything above 3 percent is non-existent. With a good farming strategy you can generate an APY as large as 100 percent from yield farming.
There are three main elements that make such returns possible:
- Liquidity mining
Liquidity mining is the process in which crypto holders lend assets to a decentralized exchange in return for rewards. This means that you can lend your UBN to protocols such as Uniswap and receive rewards from that. It creates additional incentives for you as the token rewards are added on top of the yield that is already generated by using the protocol.
Leverage is using borrowed money to amplify your buying or selling power so you can trade with more capital than you currently have in your wallet thus increasing the potential return of an investment. You can deposit your cryptos as collateral to one of the lending protocols like Balancer, Aave or Compound, and borrow other coins. You can then use the borrowed coins as collateral and borrow even more coins. By repeating the procedure, you can leverage your initial capital a few times over and generate greater returns on your initial capital.
The last element is the high risk taken such as:
- Liquidation risk which is related to leverage as previously discussed. All the loans that you are taking are over collateralized and supplied collateral is susceptible to liquidation if the collaterization ratio drops below a certain threshold.
- Smart contract bugs, platform changes, admin keys, systemic risks.
- Lastly, attack on liquidity pools
With high risk comes high reward.
Yield Farming Strategies
These are sets of steps that aim at generating a high yield on your capital. They involve at least one of the following elements:
- Lending and borrowing
- Supplying assets to liquidity pools
- Staking LP tokens
Lending and borrowing
You can for example supply stable coins such as USDC on lending platforms and start getting a return on your capital. Liquidity mining and leveraging super charges lending; however it comes with the risk of potential liquidation.
Supplying assets to liquidity pools
You can also supply UBN to one of the liquidity pools in protocols such as Uniswap and get rewarded with fees that are charged for swapping different tokens. Liquidity mining can super charge this for example, by supplying coins to different liquidity pools, you are rewarded with extra tokens.
Staking LP tokens
Some protocols incentivize you even further by allowing you to stake your LP tokens that represent participation in a liquidity pool. In conclusion, yield farming is a good way of generating passive income from your UBN if you have proper strategies in place.