Yield Farming Basics: Everything You Need To Know

Out of all use cases, yield farming is the most popular DeFi application. There are over 2,000 dApps in this space today, most of which support some sort of interest-earning feature. Why sell your crypto when you can earn while holding?

Staking, lending, liquidity pools. None of this was mainstream before 2020, yet in two short years, the DeFi total-value-locked (TVL) has gone from <1M to over $200B. Yield farming platforms were mostly responsible for this growth.

Even though today’s DeFi dApps aren’t like in 2020, yield farming will remain relevant, if not more than before.

What Is Yield Farming?

Yield farming is an umbrella term that refers to all possible strategies to consistently earn crypto passive income. It’s the platforms and leverage methods you can use to profit from idle crypto while managing risk. And in some market situations, it can be more efficient than trading.

Given the broadness of the concept, here are a few yield farming examples:

• You lock an amount of crypto in a staking decentralized application (dApp). You withdraw after a few weeks with an interest yield
• You borrow crypto at low interest to stake or lend at higher interest rewards
• You borrow crypto to leverage spatial arbitrage (buying low in platform A, selling high in platform B)
• You provide two tokens to a liquidity pool to earn a chunk of the platform’s fee revenue
• You use some yield farming software. It automatically re-allocates your loan to the platform with the highest interest rate

How Does Yield Farming Work?

In a stable market, yield farming promises passive crypto income once you find a working strategy. This is a common misconception because unless you upgrade your tactics, yield farming will eventually become unprofitable. It’s a matter of supply and demand:

• The highest interest rates go to investors that provide funds to low-liquidity platforms. This means you’re likely to lose money on price risk and impermanent loss (explained later).
• If that platform turns out to be safe, you’ll enjoy three to four-digit interest rates briefly.
• More yield farmers will join the platform to benefit from those rates.
• More people increase liquidity, which reduces interest rates (APYs).

While yield farming can be as complex as you want, there are three common strategies:

• Passive farming. To earn low but consistent returns.
• Active farming. To find the most profitable platform or strategy and use it until it no longer works in a few weeks. Then start searching again.
• Leveraged farming. To use crypto loans for interest-earning-unrelated strategies, such as arbitrage or trading.

Regardless of which one you prefer, you can choose any combination of the three types of yield farming platforms.

What Are The Different Types Of Yield Farming?

Yield farming might seem complex because of the thousands of DeFi dApps out there, each with its own features. If you research a bit, you’ll find most offer variations of the same tools. Staking, lending or borrowing, and liquidity providing:

Staking

Staking is a common feature on proof-of-stake (PoS) blockchains like Ethereum and Pulsechain. It involves locking your tokens to secure the network, meaning you’re unable to withdraw your tokens for a certain time period. Depending on how long you wait, you will earn interest rewards when it’s time to retire your initial amount.

Everything you should know about staking is:

• Staking rewards decrease when there are more contributors, just like liquidity rewards decrease with more liquidity.
• Many staking platforms allow users to unstake whenever they want. As a user, this might mean lower returns. As a validator, it involves penalties because other users rely on you.
• The simplest (and default) type is delegated staking. That means you select a validator to trust tokens on your behalf (such as a DeFi protocol or a centralized exchange). Direct staking often requires technical knowledge and high minimum token requirements.
• Staking doesn’t protect your initial amount from price activity. That’s why you should lock either amount that you don’t mind losing or coins with long-term potential.
• Staking is exclusive to PoS networks, but non-PoS protocols might use similar reward systems under this term.

To start staking, find a platform like Liquid Loans that supports staking. You connect your wallet, then choose what token to stake, how much, and how long. If it’s flexible staking, you’ll be able to click Unstake anytime to withdraw the amount and interest earned so far.

Lending

If staking is provided to the blockchain, lending is provided to users. The difference is, that interest rates change and there are more tokens available to lend. If you’re trying to protect against price volatility, you can lend a token that doesn’t change (e.g., USDL) or goes up (e.g., PLS).

Unlike traditional lending, anybody with enough collateral can borrow crypto. There are no credit checks and no entry barrier. But that doesn’t mean that lending is any riskier.

In decentralized lending platforms, smart contracts control loan agreements. If at any point, the risk of default is too high, the platform will liquidate the loan and return the full initial amount to you. The biggest concern is token price volatility.

Borrowers have flexible terms too. In Liquid Loans, you can borrow with collateral as low as 110%, there are no repayment schedules, and the interest rate is 0%. To lend or to borrow, all you need is a Web3 wallet like Metamask with crypto:

1- Select the amount you want to borrow or lend

2- Review the conditions and confirm

3- Start earning interest or yield farming with your loan

It’s also possible to borrow at low interest and lend that at high interest. You can keep lending your loan to leverage your APY. However, it reduces the liquidation margin, which makes this strategy riskier and not for everyone.

Liquidity Providing

If you can overcome the risk of price volatility, liquidity providing might be the most profitable of the three. All you need is a pair of tokens that move together or stay the same. It could be BTC-ETH or USDL-USDT.

Liquidity providing is about lending to decentralized exchanges (DEXs), so traders can use those funds to swap tokens. Liquidity uses complicated automated market makers (AMMs) and ratios to balance both parties. This means liquidity providers can always withdraw their amount, and traders can always swap tokens, even if there are no sellers to match them.

To meet both goals, AMMs are programmed to balance the pool proportion (typically 50%/50%) by changing prices. If traders buy Token A more than Token B, Token A becomes expensive and Token B becomes underpriced (respect market prices outside the pool). Price changes cause arbitrage traders to balance tokens back to a 50/50 proportion, and if market prices were stable, liquidity providers can withdraw the initial amount with initial value plus profits.

These profits are proportional to the token amount contributed. Let’s say a BTC-ETH pool has a total of $50K each (and $100K total). If an investor contributes $5K worth of BTC and ETH each ($10K), he’s able to earn 10% of the platform’s fee revenue.

If a larger investor comes in and increases the pool size to $200K, the previous investor’s contribution falls from 10% to 5%.

Smart contracts know how much each provider deserves because when you provide liquidity, you earn liquidity-pool (LP) tokens as a receipt. Providers can use these to yield farms, withdraw their liquidity, or transfer ownership.

Every DEX like UniSwap v3 has several pools for every token pair, each with liquidity providers, AMMs, and LP tokens.

To provide liquidity, you go to any DEX and find the Liquidity/Farm Tab. Select your pool, choose your amount of funds, and confirm to start earning.

Yield Farming Examples

We said most of the 2,000+ DeFi dApps are similar, which makes them straightforward. But do you know which one is best for yield farming? The answer will depend on your strategy, the features, and the network.

Consider that most dApps belong to Ethereum, the most expensive network. If you don’t want to waste months of interest on gas fees, the PulseChain fork makes a great alternative. It’s a new network many don’t know about yet, and the best DeFi yield protocols are:

PulseChain Validating

PulseChain is like staking Ethereum 2.0., except there is less competition, higher yields, and 4x lower fees. There are over 500 validators like Liquid Loans, many of which earn an average of 100,000 tPLS every 24h (block time of 3 seconds). If you want to become a validator, you will need:

• To add the Pulsechain Testnet to your WEB3 wallet custom networks
• Stake over 500,000 tPLS
• Wait for the next rotation to start in ~24h

It’s reasonable to expect increased staking rewards with the launch of Pulsechain Mainnet. It’s a high-performance Ethereum-fork blockchain that will bring a new generation of DeFi protocols. You can join the movement now by addingPLS Testnet.

Liquid Loans Stability Pool

Unlike liquidity pools, stability pools consist of a single token (typically a stablecoin) that provides liquidity to the protocol. It allows platforms to manage debts caused by user loan liquidations and protect stablecoins with liquidity. As a reward, stability providers receive token rewards and a proportional part of the lost collateral.

Liquid Loans has a USDL stability pool. Users can deposit USDL to earn LOAN tokens for stabilizing the protocol’s liquidity. And just like DEXs reward with fee revenue, Liquid Loans rewards you with liquidation losses when they happen.

Suppose you deposit $10K LUSD to a $100K USDL pool, which is a 10% contribution. If a borrower fails to repay a $10K loan with $11K collateral, you’d get up to $1100 on liquidation. In addition, theLiquid Loans Stability Pool has generated 159.4% APRin LOAN since the fork.

PLSX Staking

PLSX is the native token of the Pulsechain exchange (PulseX). You’ll be able to swap any PRC-20 tokens faster and cheaper than on Ethereum.

And to swap tokens, we need PLSX liquidity pools. There was a version-2b Testnet in early 2022 when some liquidity pools offered over 60% APR. Note that PLSX is deflationary and limited, so staking works differently:

• Find the PLSX pool on PulseX.com (like stability pools, there’s a single token)
• Select the amount and click stake
• Once you have rewards, click Harvest to earn a staking-rewards token (PRT)
• After earning PRT, you can swap it in the exchange for PLSX and stake again
• If you want to withdraw, you click Unstake

Liquid Loans Borrowing

Liquid Loans allows you to borrow without interest rates. And because there are no repayment schedules, you earn interest on your loan with almost any DeFi yield platform. To get started:

• Get Pulse tokens. You can convert ETH to PLS or trade other PRC-20 tokens for PLS on PulseX
• Offer 110%+ PLS collateral to get your loan in USDL
• Deposit USDL in the Liquid Loans Stability Pool to earn liquidations revenue in PLS. Also receive APR in LOAN tokens.

By providing USDL, your PLS has earned more PLS and LOAN. You can sell these for USDL, or you can stake LOAN to keep earning.

LOAN Staking

Even though you can’t stake LUSD in the stability pool, you can stake the LOAN you earn on the protocol. This creates an earning cycle that allows you to reinvest, or at least minimize liquidation risk. A yield farm:

1. Open a vault by depositing PLS for USDL loans
2. Add USDL to the stability pool to get PLS and LOAN
3. Stake LOAN to earn PLS and PLS from the borrowing fee revenue

With the right yield-farming strategy, you never have to worry about selling.

Yield Farming Risks

You may know now the earning strategy, but risk management is the other side of the coin. Oftentimes you’ll find platforms offering higher returns on unknown tokens. But is it worth risking the initial amount?

• Rug pulls: Especially in 2020, many yield tokens appeared with APYs above 1000%. These had no liquidity nor product-market fit, so they fell to zero as quickly as they rose. Sometimes the token has no value, sometimes it’s the developer team that abandons the project with investors’ funds.
• Smart contract exploits: Smart contracts might be autonomous and trustless, but they’re designed by people. People sometimes make mistakes or fail to limit the program only to the intended uses. It’s a matter of time before cyber-attackers find money glitches, and you don’t want to invest too much in that protocol when it happens.
• Automatic liquidation: If you’re a small trader, yield rewards might make no sense unless you increase your funding. You can earn interest from borrowed money, but it reduces the liquidation margin. One day you might wake up with your initial funds liquidated because your token had a 1000% price spike in a few seconds.
• Impermanent loss: Yield farming only makes sense when it’s more profitable than holding. When prices have upwards volatility, pools tend to unbalance proportions and pair prices. You might make a positive ROI, but if you could have earned more by just holding, you suffered an impermanent loss.

Should You Start Yield Farming?

Some yield farming strategies might be too complex or risky to be worth the work. Others are so simple anyone can do it. If you’re going to hold anyway, you have everything to gain and nothing to lose.

If yield farming is new to you, passive strategies are recommended. Find a token you want to invest long-term and earn interest from staking or lending. If you know what you’re doing and want higher rewards, it’s worth looking into high-yield platforms and leveraging loans. Yield farming has something valuable to offer for any crypto investor.