Blockchain and Cryptocurrency Advanced - What is Yield Farming?
Yield farming is one of the most popular aspects in the world of decentralized finance, allowing anyone to put their cryptocurrency asset to work and earn interest in return based on the estimated APY. In cryptocurrency, yield farming is basically the process where anyone can earn passive income by locking up a particular cryptocurrency asset based on the percentage yields or APY. In yield farming, anyone can earn either fixed returns or variable returns based on the specific cryptocurrency asset and the percentage yields.
In yield farming, cryptocurrency investors can earn more passive income or maximize their investment by taking advantage of different DeFi protocols or yield farming platforms. On DeFi protocols such as uniswap, investors can lock up their cryptocurrency assets in the liquidity pools and become liquidity providers. The liquidity providers earn a proportion of the transaction fees for adding assets to the liquidity pools based on the percentage yield. If done properly, yield farming is a great way for any investor to gain more value and profit from their investment.
How does Yield Farming Work?
In cryptocurrency, when we talk of yield farming, it is pretty much the process anyone can put their cryptocurrency asset to work and earn interest in return based on the estimated APY. Investors can earn more passive income or maximize their investment by taking advantage of different DeFi protocols or yield farming platforms. If we think of the conventional banking system where banks provide loans to other users and collect interest in return, yield farming is very much similar. By yield farming in cryptocurrency, it means that cryptocurrency holders can put their cryptocurrency asset to work and earn interest in return based on the estimated APY by locking up their funds over a period of time.
A clear example of yield farming in cryptocurrency is providing liquidity on uniswap. Cryptocurrency holders can lock up their cryptocurrency assets in the liquidity pools and become liquidity providers. The liquidity providers earn a proportion of the transaction fees in return for adding assets to the liquidity pools based on the percentage yield. On Uniswap, the Liquidity pools are simply pairs of ETH and ERC-20 tokens that are swapped for each other on the uniswap DEX protocol. ETH and DAI is a very popular liquidity pool on uniswap. Yield farming operates on the concept of automated market maker also known as AMM.
When users add liquidity into the liquidity pool, they would start earning a portion from the transaction fees. Any amount can be used, however, it has to be at a ratio of 50/50. What this means is that the two tokens to be added into the liquidity pool will be 50% each. Once the liquidity is added, anytime a trader performs a swap transaction on uniswap protocol, that trader would have to pay a fee of 0.3% which ends up going into the pool and is shared proportionally to each liquidity provider based on amount of tokens deposited into the pool.
