Yield Farming: What are the Effects on Our Economy?

1. Introduce

The Decentralized Finance (DeFi) platform has long been seen as the biggest step forward in blockchain technology. However, what makes DeFi applications unique? It's permissionless - anyone (or anything, such as a smart contract) with an Internet connection and the right wallet, can interact with these apps. . In addition, this method usually does not require trust from any custodians or intermediaries. In other words, it is the ability to transact without trust. So, under what circumstances are these properties enabled?

One of the new concepts that have emerged is yield farming explained. It's a way to earn the maximum amount of crypto rewards you have, using permissionless liquidity protocols. It allows anyone to earn a passive income using a plethora of financial "pieces" built on top of the Ethereum decentralized ecosystem. As a result, this form of yield optimization could fundamentally change the way investors HODL cryptos in the future. Because, why keep your assets idle when you can profit from them?

So, how do yield miners take care of their investments? And what kind of productivity can they expect? And where should you start if you are thinking of becoming a productive farmer? We will explain all of them in this article.

2. How does Yield Farming work?

Yield Farming is closely related to a model known as the automated market maker (AMM). It usually involves liquidity providers (LPs) and general liquidity mechanisms. Let's see how it works.

Liquidity providers deposit cryptocurrencies into a liquidity pool. This pool creates an exchange market where users can lend, borrow or exchange tokens. The use of these platforms will incur fees. This cost will be paid to the liquidity providers according to the liquidity market share that he or she holds in the pool. This is basically how the AMM market maker works.

However, the implementation can be very different - not to mention the fact that this is a new technology. There is no doubt that we will see new approaches that are improvements to existing implementations.

In addition to fees, another incentive for investors to deposit into the general liquidity mechanism could be the distribution of new tokens. For example, there may be no way to buy tokens on the open market, just in small amounts. Meanwhile, it is possible to accumulate tokens by granting liquidity to a specific fund.

All delivery rules will depend on the unique implementation of the protocol. The bottom line is that liquidity providers receive a profit based on the amount of liquidity they are granting the mechanism.

Deposits are usually stablecoins pegged to USD – although this is not a requirement. Some of the most popular stable coins used in DeFi are DAI, USDT, USDC, BUSD, and others. Some protocols will generate tokens that represent the money you have deposited into the system. For example, if you deposit DAI into Compound, you will receive cDAI or Compound DAI. If you deposit ETH into Compound, you will receive cETH.

As you can imagine, this can be a complex multi-layered process. You may send your cDAI into another protocol that mints a third message on behalf of cDAI on behalf of your DAI. And the process continues like that. These sequences can get complicated and hard to follow.

3. How is Yield Farming profit calculated?

Normally, Yield Farming profits are calculated annually. This estimates the return you can expect over a year.

Some commonly used metrics are Annual Percentage Rate (APR) and Annual Percentage Yield (APY). The difference between them is that APR doesn't take into account the effect of compounding, while APY does. Gross profit, in this case, means directly reinvesting profits to generate more profits. Be aware, however, that APR and APY can be used interchangeably.

It is also important to note that these are estimates and projections only. Even the short-term rewards are quite difficult to accurately estimate. The reason why? Yield Farming is a highly competitive and fast-paced market, and rewards can fluctuate rapidly. If the yield mining strategy works for a while, many yield miners will seize the opportunity and it may stop being highly profitable.

Since APR and APY come from legacy markets, DeFi may need to find its own metrics to calculate returns. Due to the fast pace of DeFi, it may be necessary to estimate weekly or even daily returns.

4. System Effects

While liquidity can be seen as a moat, it is entirely impenetrable to cross. The Yield Farming incentive can be used to squeeze out the liquidity of other protocols, potentially leading to a bearish effect, where if enough liquidity moves in, the liquidity-based network effect can effectively switch from the old protocol to the new one. This approach is known as vampire mining.

While it is still unknown if this approach will work in the long run, it shows the importance not only of a protocol's liquidity but also of how Yield Farming can be used to wage a liquidity war. account. In the end, Yield Farming is simply a tool that can be used to achieve a multitude of goals.

Tokens generated from Yield Farming incentivize users to deposit liquidity, they also provide users with a share of the fees that the Defi application generates and incentivize governance participation regarding the future of the protocol, wallet. such as voting on whether to add another pool or not?

However, for the governance of Defi applications to become decentralized, these tokens need to be widely distributed to independent users, which is where the features of Yield Farming come into play.

5. What does the future for yield farming look like? (Guess)

COMP turned out to be a bit of a surprise to the DeFi world technically and otherwise. It has inspired a new wave of thought.

Nexus Mutual founder Hugh Karp commented:

“Other projects are working on similar things.”

In fact, many sources say that projects from completely new brands will debut with these models.

We may soon see more trivial yield farming applications. For example, profit-sharing forms reward certain types of behavior.

For example, imagine if COMP holders decided the protocol needed more people to put their coins in and let the coins stay there longer. The community can create a proposal to remove some of the token's yield and only pay that part for tokens that are more than 6 months old. The number probably won't be much, but an investor with the right timing and risk profile can weigh in before withdrawing.

(This proposition used to happen in traditional finance: 10-Year Treasuries typically offer more yields than 1-Month T-bills, although both are backed by Uncle Sam's faith and credit – 12-month certificates of deposit paying higher interest than checking accounts at the same bank, etc.)

As the field becomes stronger, architects will come up with ever more aggressive ways to optimize liquidity incentives in increasingly subtle ways. We could see token holders offering more ways for investors to profit from every DeFi nook.

There are many questions for this nascent industry: What will MakerDAO do to restore DeFi's kingship? Will Uniswap join the trend of liquidity mining? Anyone going to stick all these governance tokens in a decentralized autonomous organization (DAO)? Or will you become a yield farmer?

Whatever happens, the yield farmer will continue to move fast forward. Some fresh fields may open up but some may soon yield much less delicious fruit.

But the very nice thing about the mining industry in DeFi is how easy it is to switch sectors.

Yield Farming is a new stub financial instrument in DeFi that has proven to effectively deliver both incentivizing liquidity and enabling a fair distribution of tokens. DeFi stakeholders also benefited greatly, as Yield Farming reduced the slippage for token swaps across many DeFi applications and fostered the growth of strong communities. It has also allowed countless projects to launch their development to now secure hundreds of millions to billions of user funds.

6. Conclusion

Those who want to do Yield farming will use very complex strategies. They move their cryptocurrencies between different lending markets to maximize their profits. They will also keep the best yield mining strategies secret. The reason why? The more people know about a strategy, the less effective it becomes. Increasing yields is the fertile ground of the decentralized finance (DeFi) sector, where farmers compete for the chance to grow the best crops.

In general, the cryptocurrency market is actively growing, new companies and infrastructure projects appear. And the fact that the legal institutions and software development services are trying to assess the impact of bitcoin and other digital currencies on the development of the economy is a positive signal. This proves once again that cryptocurrencies are a multifaceted concept, and the relationship arising from their use can be interpreted in different ways, and no regulator has yet come to a consensus on this issue.

This article does not necessarily reflect the opinions of the editors or the management of EconoTimes