Yield farming is an investment strategy in decentralised finance or DeFi. It involves lending or staking your cryptocurrency coins or tokens to get rewards in the form of transaction fees or interest.
Decentralised finance (DeFi), an emerging financial technology that aims to remove intermediaries in financial transactions, has opened up multiple avenues of income for investors. Yield farming is one such investment strategy in DeFi. It involves lending or staking your cryptocurrency coins or tokens to get rewards in the form of transaction fees or interest. This is somewhat similar to earning interest from a bank account; you are technically lending money to the bank. Only yield farming can be riskier, volatile, and complicated unlike putting money in a bank.
Yield farming involves moving crypto through different marketplaces. There is also an element of yield farming where the strategy becomes less effective when more people know about it. But yield farming is currently the most significant growth driver of the DeFi sector, helping it expand from a market cap of $500 million to $10 billion in 2020 alone. Here's a primer on yield farming.
How does yield farming work?
Users providing their cryptocurrencies for the functioning of the DeFi platform are known as liquidity providers (LPs). These LPs provide coins or tokens to a liquidity pool—a smart contract-based decentralised application (dApp) that contains all the funds. Once the LPs lock tokens into a liquidity fund they are awarded a fee or interest generated from the underlying DeFi platform the liquidity pool is on.