Yield farming has quickly become one of the most popular methods for earning passive income with cryptocurrencies. However, the concept itself remains a mystery to many. Getting started with yield farming can seem intimidating and confusing! That’s why we’ll clear up any confusion and provide all the information you need to understand yield farming.
In this section, we’ll break down what yield farming is, how it works, and how you can get started earning yield with your crypto assets.
Let’s begin!
What Is Yield Farming?
So, what exactly is yield farming?
The term consists of two words, so let’s break them down:
- "Yield" refers to the passive rewards you earn by participating in a process. The rewards are passive because you don’t need to be actively involved all the time.
- "Farming" simply means consistently acquiring something.
Put together, "yield farming" is a method of receiving passive profits (in the form of some asset) on a recurring basis. In principle, it’s quite simple!
In the context of cryptocurrency, yield farming works similarly. You allocate some of your crypto into a project and start earning passive, regular yields. In other words, it’s a way to generate passive income.
Actually, "investing" might not even be the right term here. Instead, you "lock up" your cryptocurrency for a certain period. Let me illustrate with an example.
Imagine you have a bag of 10 candies. One day, your friend approaches you with a proposition—if you give him the bag for a week, he will return with 12 candies.
Your friend will use the candies from your bag to trade with other people. But by the end of the week, no matter what happens, you’ll still get 12 candies back.
Do you really care how your friend uses the candies during the week? Does it matter? Not really— what matters is that you get all your candies back, plus extra!
Essentially, this is how yield farming works in crypto. Of course, there are different types of yield farming you can participate in. Let’s examine each type and see which might be the most worthwhile.
Crypto Lending
The first form of yield farming you might encounter is crypto lending. This concept has become very popular over the past couple of years!
Several decentralized finance (DeFi) projects allow crypto enthusiasts to borrow and lend cryptocurrencies—platforms like Aave are great examples.
The most common way to participate in yield farming on such platforms is by lending your crypto. Suppose you have 1 Bitcoin and don’t plan to sell or trade it anytime soon.
You can go to a platform like Aave and lend your Bitcoin to others. Don’t worry—the process is automated and conducted through special pools, so the risks involved are minimal. However, if you’re unfamiliar with liquidity pools, I highly recommend reading about that topic to better understand this concept.
Depending on several factors, you can expect to earn up to or even more than 34% APR (Annual Percentage Rate). In other words, within a year, you could end up with an additional 0.34 BTC—a significant return!
To put that in perspective, traditional banking institutions rarely offer APRs exceeding 1%. It’s easy to see why crypto yield farming is so popular!
Another great feature of crypto lending is that, in most cases, you can withdraw your funds at any time. So if you end up needing that 1 Bitcoin, you can simply take it out without any strings attached.
Next, let’s talk about borrowing. I admit this is a bit trickier, as it’s one of the more unique forms of yield farming.
Imagine you have a very old and valuable painting. You love that painting and spend a lot of time admiring it, so you don’t want to sell it! However, you’re in a bit of a bind—you really need some money.
What you can do is take out a loan while using your painting as collateral for the loan. Once you repay the loan (plus interest), you’ll get your painting back. Now, since the painting is old and valuable, its market price will likely increase during the loan period.
This is the general idea of how yield farming works when borrowing crypto. If you believe Bitcoin is a great cryptocurrency and its price will rise, you can use it as collateral for your loan. Then, you’ll have some money to use while still holding BTC as collateral, hoping that by the time you repay the loan, Bitcoin will be worth more than when you started!
There’s an even more advanced method of yield farming involving borrowing crypto, but it’s a bit complex. We’ll cover it later as a bonus—so make sure to read until the end!
Providing Liquidity
The second major form of yield farming is being a liquidity provider. This might sound fancy, but the core idea behind it is simple—to fully understand it, you should read up on liquidity pools.
A liquidity provider is someone who supplies funds to a decentralized cryptocurrency exchange and, in return, earns passive income. Suppose you have $1,000 on hand and want to put it to work. First, you convert that money into two cryptocurrencies—say, Ethereum and AAVE.
Then, you supply ETH and AAVE to a decentralized exchange like Uniswap. People will use your Ethereum and AAVE to swap from one cryptocurrency to another. These swaps involve fees!
These fees are collected by Uniswap and distributed to liquidity providers as payment for their liquidity. It’s a simple but highly effective model!
Your actual passive earnings will depend on several factors. First, the amount of liquidity you provide and how many other liquidity providers are in the same pool. If the ETH-AAVE pool is large and has thousands of other providers, you might earn smaller returns.
However, if you supply a significant amount of tokens to the pool, your returns will be larger.
Another thing to note is the fees charged by the decentralized exchange. Depending on these fees, your rewards will vary! Even so, Uniswap remains one of the most popular decentralized exchanges for providing liquidity and earning passive interest.
Staking
The third method of participating in yield farming is one many crypto enthusiasts are familiar with— staking.
At first glance, staking seems very similar to providing liquidity—you hold some cryptocurrency or tokens and supply them to a specific platform to earn passive returns. However, diving deeper, things aren’t that simple. If you want to learn more, check out the section on staking and the differences between coins and tokens.
For the sake of this section, we’ll simply say that staking involves locking your tokens in a network so they can confirm transactions for others. Only specific tokens can be staked—those built on the proof-of-stake consensus model!
A simple example of staking is the Cardano project and its native token, ADA. You can buy ADA on most top cryptocurrency exchanges, like Binance or Coinbase. Once you have ADA, you need to find a staking pool—the easiest way is to transfer your ADA to a Yoroi wallet. Yoroi is a browser extension-based wallet and one of the most popular places to store and stake ADA. Plus, Yoroi provides access to multiple pools directly from the wallet!
All you need to do is choose your desired pool and delegate your ADA tokens to it. Over time, your coins will start earning passive rewards!
Admittedly, this is a topic worth its own dedicated section.
Another way to stake tokens and farm yield is through cryptocurrency exchanges themselves. Some of the most popular trading platforms have started offering staking features to users—you can buy coins and then stake them directly from your exchange-based crypto wallet, often with just the push of a button!
In most cases, your yield rewards will be in the same token you staked. Alternatively, you might receive "LP tokens," also known as liquidity provider tokens. You can then trade these LP tokens for another cryptocurrency, like Ethereum.
Redistribution Fees
The last important method of participating in yield farming is holding cryptocurrencies that have redistribution fees.
Sound fancy? It’s actually super simple!
Some cryptocurrencies have what’s called a "redistribution fee." This means that whenever you trade that cryptocurrency, part of the fee you pay for the transaction is distributed to other holders of that cryptocurrency.
The most famous example might be Safemoon. This is a very popular cryptocurrency that features redistribution fees as well as a token burn mechanism.
Token burning might sound complex, but it’s straightforward. When you make a transaction using the cryptocurrency, you pay a fee in the same token—so, if you want to send 10 Safemoon to a friend, you might spend 1 Safemoon token as a transaction fee.
Some of that fee is redistributed to token holders—for example, they might share 0.5 Safemoon tokens. The other 0.5 Safemoon is sent to an inactive, inaccessible wallet. This is called "token burning"—the tokens in that wallet are lost forever. This way, the token fights inflation and still rewards holders!
Now, obviously, with this type of yield farming, there are various technical details to consider. The token’s price can be highly volatile, and you need to hold a significant amount of tokens to earn noticeable yields.
Leveraged Loans
After covering the four main yield farming methods, I also want to share a bonus strategy. It’s called "leveraged loans"—I’m including it as a bonus because it’s a bit more advanced than the other yield farming strategies we’ve discussed.
Suppose you have $100 worth of ETH. You decide to lend out your ETH and borrow some **DOGE coins**, using your ETH as collateral. Since your collateral always needs to be greater than your loan, you’ll receive $70 worth of Dogecoin in return.
Now, what you do is go to a cryptocurrency exchange and trade your Dogecoin for Ethereum. You now have ETH again! So, you bring it back to the lending platform, deposit the new ETH, borrow more Dogecoin—and repeat the process!
Since your collateral is always higher than your loan, there is a limit to how far you can go. However, by the end, you’ll have much more ETH on the lending platform than you started with.
This isn’t a very simple process, as it requires understanding APRs, different lending platforms, and good timing. Additionally, cryptocurrency prices are highly volatile—if the price of ETH drops too much, you could end up having your position liquidated. However, with some practice, this can be a very interesting yield farming strategy!
In closing, when it comes to yield farming, there are multiple approaches you can take, each with different levels of risk and reward. In short, you should focus on top-rated projects and cryptocurrencies that have historically shown resistance to sharp price swings and overall market volatility.
👉 Explore advanced yield farming strategies
Frequently Asked Questions
What is yield farming in simple terms?
Yield farming is a way to earn passive income by lending or staking your cryptocurrencies in decentralized finance (DeFi) protocols. In return, you receive rewards, usually in the form of additional tokens or interest payments.
Is yield farming safe?
Yield farming involves risks, including smart contract vulnerabilities, market volatility, and impermanent loss. It's essential to use well-audited platforms and understand the risks before participating.
How much can you earn from yield farming?
Earnings vary based on the platform, token pair, and market conditions. APRs can range from single digits to over 100%, but higher returns often come with higher risks.
Can I lose money yield farming?
Yes, it's possible to lose money due to token price fluctuations, project failures, or hacks. Always do thorough research and never invest more than you can afford to lose.
Do I need technical knowledge to start yield farming?
While basic understanding of DeFi and cryptocurrencies helps, many platforms offer user-friendly interfaces. However, knowing how to manage private keys and understand transaction fees is important.
What’s the difference between yield farming and staking?
Yield farming often involves providing liquidity to DeFi protocols, while staking usually means locking tokens to support a blockchain network’s operations. Both offer rewards but operate differently.
How do I choose a yield farming platform?
Look for platforms with strong security audits, high total value locked (TVL), and a good reputation in the community. Start with well-known protocols to minimize risks.