AcademyDeFi

Everything you need to know about DeFi and Yield Farming

Yield Farming is an investment practice in DeFi that is used to maximize profits. What investors do is generate profits from their assets without having to sell and buy them repeatedly.

Share

Written by Pavel Rabtsevich

05 Oct 2020

13 min

DeFi is a significant trend

DeFi seeks to develop small traditional financial pieces but with an extra degree of transparency and decentralization. As if they were Lego pieces, these little pieces can be combined to create a whole ecosystem of small solutions that together form an excellent solution for finances that invalidate the need for centralized and opaque financial institutions that no longer provide value.

This idea has driven the term “DeFi,” which has brought its evolution to the present day. Today it is impossible to ignore the very high impact DeFi has on the crypto world. For that reason, we opened a space to know what DeFi is and how this idea is changing the global financial world.

DeFi, the idea that is changing the financial world

Imagine a world where anyone could create transparent, fair, and efficient financial products, making banks, big finance companies, lenders, and insurance companies, become unnecessary. But also a world where anyone can interact with those products freely. Well, this is what DeFi is all about. That is to say, it wants to convert the centralized financial structures that we have now, into decentralized formats, without trusted third parties, executed on smart contracts, within a blockchain where a written and unalterable record of every action performed is transparently reflected.

All actions performed on the platform are visible and immutably recorded in the blockchain as well. Maybe you don’t know how to verify the reliability of the DeFi service. Still, due to its characteristic of transparency, thousands of eyes will be able to analyze and question it, alerting of its malfunctioning if this is the case.

What DeFi is really about?

The idea is simple. If all traditional financial institutions (banks, exchanges) are just software controlled by some legal entities, why not make all these institutions on Ethereum smart contracts?

This is how protocols appeared, which allow without an intermediary to trade crypto on decentralized exchanges (Uniswap), to lend (Compound), to manage monetary policy and issue stakes (MakerDAO), to rebalance assets (TokenSets), to create derivatives (UMA), to ensure risks (Nexus Mutual) and in general to do everything that traditional financial institutions do.

While ICO was about raising capital, DeFi is about all the other functions of a traditional financial market.

Great opportunities of DeFi platforms

As you have seen, DeFi platforms open up a whole range of new ways and business opportunities. In this case, the possibilities are gigantic and only limited by the imagination of new business schemes. We are talking about economic diversification at levels only imagined until now.

  • Thanks to DeFi, we can now include complex economic systems within games and create a real flow of money within them. This would give shape to games in which we can interact with real money; even we can make a total income from the same game just by playing. This is certainly something that has attracted the attention of several development companies that are now experimenting with such capabilities.
  • Banking and the traditional financial system have also been attracted by DeFi. Firstly, because DeFi tools allow you to automate tasks, saving large amounts of money and response times.
  • Tthe use of DeFi generates more transparency and eliminates these systems’ susceptibilities and erroneous conceptualizations.
  • And finally, because DeFi removes intermediaries. We are leaving only actions between the smart contract representing the bank, and us, the users of the system, as the customers. A situation that improves security protects our privacy and allows us to take quick action on our system’s requests.

 

Technology capabilities of DeFi

But what is the DeFi for us today? First of all, DeFis serve as a financial bridge between the crypto holders and a world of financial services that can be provided by using that wealth to generate more wealth.

That said, among the potential causes of DeFi use, we can mention

  • Decentralized lending systems: This is one of the prominent cases of DeFi today. The system is simple: if a person wants a loan and wants to use his crypto as collateral or guarantee, he can do it without problems. The system works similarly to FinTechs or traditional finance. But DeFi usually offers better interest conditions, and usually, the loans are approved almost instantly. Gone are the bank’s hours, sending digital documents, and waiting days for a response, with DeFi interacting with the DApp, making the required security deposit. You will have the money you have requested in loan in your possession, and all in a few minutes.
  • Decentralized markets: another case of using DeFi is the decentralized markets. Creations such as decentralized exchanges (DEX), investment pools, financial derivatives, staking systems, prediction markets, and more are possible thanks to DeFi.
  • Payment systems: another use for DeFi is payment systems. These platforms’ characteristics allow them to be trusted bridges to process payments from different blockchains using external, decentralized, and autonomous infrastructure.
  • Banking and insurance services: another use of DeFi is to offer “banking” type services without being precisely a bank. For example, there are DeFi protocols that allow their users to make a particular investment. But after a while, you can receive that investment with a profit margin, and all thanks to the interest it has generated. But some systems allow the issuance of stable coins (stablecoins) and digital identification and financial insurance systems.

At this point, it is clear that the potential of DeFi to offer services and solutions is varied, as varied as the inventiveness of the people who develop such systems.

How does DeFi help crypto enthusiasts gain profit?

What is Yield Farming?

Yield Farming is an investment practice in DeFi that is used to maximize profits. What investors do is generate profits from their assets without having to sell and buy them repeatedly.

At DeFi, this possibility exists because many protocols allow for different ways of making a profit. For example, you can profit by staking a certain amount of cryptocurrencies for a specific time, and staking consists of blocking funds in a cryptocurrency wallet to receive interest in return. This practice is often complemented with governance tokens or the possibility of applying for low-interest loans. You can imagine Yield Farming, like savings deposited in a superbank (DeFi), where it is leveraged to obtain better profits.

As a result, such activities’ gains can be significant or a complete loss, as in any high-risk investment. However, the risk is the game, and in the crypto world, the risk is a fundamental part of the market. Everyone plays that game and expects luck to smile. The situation, as chaotic as it may seem, is not so bad. Many of the DeFi protocols that exist today allow good profits to be made using this risky investment form.

Yield farming is not new to the DeFi ecosystem. Yield Farming has been practiced in MakerDAO practically since its inception. But the current DeFi boom, reminiscent of ICO fever, has taken this practice to an all-time high. As a result, most DeFi protocols have seen a sharp rise in their capitalization, and the Ethereum blockchain has had to adjust to increasing demand for transactions on its blocks.

How does this whole process work?

Cryptocurrency farming consists of positioning our assets in favor of a platform to obtain a return. The platform on which we trust our currencies is responsible for returning those profits to us.

Liquidity providers deposit funds in a liquidity pool. This reserve feeds a marketplace where users can make loans, take out loans, or exchange tokens. The use of these platforms involves commissions (fees), which are paid to the liquidity providers according to their share of the liquidity pool.

However, implementations can vary greatly – not to mention that this is a new technology. There is no doubt that we will witness new approaches that will enhance current implementations.

In addition to fees, another incentive to add funds to a liquidity pool could be the distribution of a new token. For example, there may be no way to buy a token on the open market except in very small amounts but on the other hand, it could be accumulated by providing liquidity to a specific reserve.

The distribution rules will depend on the unique implementation of the protocol. At the end of the day, liquidity providers will get a return based on the amount of liquidity they contribute to the pool.

The funds deposited are usually stablecoins (stable currencies) anchored to the USD – although this is not a general requirement. Some of the most common stablecoins used at DeFi are DAI, USDT, USDC, BUSD, among others. Some protocols will issue tokens that represent the currencies that you have deposited in the system. For example, if you deposit DAI in Compound, you will receive cDAI or Compound DAI. If you deposit ETH in Compound, you will receive cETH.

As you can imagine, there can be many levels of complexity here. You could deposit your cDAI in another protocol that would coin the third token to represent your cDAI which, in turn, represents your DAI. And so on. These strings can be very complex and difficult to follow.

What is Liquidity Mining?

The goal is to generate greater liquidity. Thus, the money invested is transformed into an investment and a generator of rewards associated with that capital injected into the liquidity pool.

Liquidity Mining is a Proof of Stake (PoS) system. Although with some modifications in its operation. The primary mission is to generate governance or reward tokens to whoever participates in the protocol that implements this system.

Indeed, the system is striking for the fact that investing in the system not only generates income from the operation of the same, whether by making loans, but also allows us to generate revenue in the form of tokens’ platform. Thus, it could be seen as a double profit. Of course, it doesn’t double the profits, but it provides a significant boost. But honestly, this type is nothing facing such a great opportunity as “yield farming”.

The different types of Yield Farming

There are different types of ways to earn tokens on Yield Farming, so, there are few ways:

Lending

Lending is another way to put our tokens in favor of a platform. Our tokens will be lent to other users, and therefore we will obtain return over time. The venue is in charge of connecting both users, lender, and receiver in a P2P operation.

What Yield Farming participants are interested in is making a profit on this loan; this profit comes when the borrower pays back his loan.

This yield is expressed as a percentage benefit based on the loan, which is generally repaid in the same currency borrowed by the users themselves, and not in a different one.

Staking

Staking is also part of Yield Farming; this may be the best-known method as blockchain as Tezos has popularized it. This system is seen in the Proof of Stake chains, which validate and create new blocks through staking.

In the absence of miners in these blockchains, there are validators, which leave their assets blocked so that the blockchain randomly uses these tokens to generate a new block; this is known as betting tokens in favor of a network.

The tokens chosen by the network are random; the more blocks we have staked, we get a higher probability that our tokens are selected to create a new block. This system makes the investment that a miner would make in hardware is made directly on the network, helping it remain safe because these validators are interested in the network’s continued operation.

Due to this work done for the blockchain, the validators get a reward, which varies according to the network and the number of blocks bet. In some networks, all validators receive rewards proportional to the number of tokens they have positioned in favor of the network.

These rewards are based on interest, and to obtain them, Yield Farming participants will only have to keep their tokens in Guarda.

Advantages of Yield Farming

  • Yield Farming can be performed by any person belonging to a DeFi ecosystem on the platforms that encourage this activity.
  • It is only necessary to make a deposit with a certain amount of crypto-currencies of those supported by the DeFi ecosystem protocols, to obtain some reward. This reward is proportional to the amount deposited, and the time the deposit remains in the Ethereum blockchain.
  • You can also make a profit by borrowing in the different protocols of DeFi.
  • With the right information, substantial interest can be earned by doing Yield Farming.
  • It provides liquidity to the platforms so that they can increase the number of crypto in each loan.
  • Through Yield Farming, people can make their money work with attractive interest rates.

Disadvantages of Yield Farming

Yield Farming is an activity that, despite providing profitable returns on investment, carries certain risks inherent in crypto.

  • The intensity of the Yield Farming activity distorts the value of the crypt-currencies in which the demand is higher, thus causing their destabilization. To counteract the destabilization in the cryptocurrencies, collateralization is applied, anchoring the cryptocurrency value to a real-world asset (gold, oil, USD, Euro, among others), even to other cryptocurrencies.
  • Yield Farming’s activity is very fragile and involves a lot of risk for investors. In general, an attack on a platform on which your money rests, or an abrupt fall in the cryptocurrency, or some eventuality in the collateralization, is enough, and a hope of big profits could turn into a loss of money.
Share

Guarda Wallet

Create crypto wallet

Use our web-based multi-currency wallet if you want to easily receive, store, send and exchange your coins.

Create wallet

Want to buy Crypto?

Buy crypto

Buying cryptocurrency made easy. Here you buy crypto with your Visa/MasterCard or a bank transfer in few simple steps.

Buy crypto

Related articles

Earn YFI with Yearn Finance

Earn YFI with Yearn Finance

The Yearn Finance platform provides the opportunity for crypto holders to participate in Yield Farming by interacting with DeFi-protocols. Farming on a blockchain is similar to the usual planting of seeds in the ground for their multiplication.

Share
What is Decentralized Finance (DeFi)?

What is Decentralized Finance (DeFi)?

The main goal of Decentralized Finance is to create an open, free, and transparent ecosystem of financial services that is available to everyone and not controlled by a centralized government. Throughout Defi projects, users take full control of their assets and interact with the ecosystem through peer-to-peer (P2P) decentralized applications (dApps).

Share