„DeFi is not just a new way to make money. It’s a new way to program money“
Andre Cronje
Yield farming is a way to earn passive income by lending or staking cryptocurrencies on decentralized finance (DeFi) platforms. In this article, we’ll explain the basic concepts of yield farming and how it works.
What is Yield Farming?
Yield farming, also known as liquidity mining, is the process of providing liquidity to decentralized exchanges (DEXs) or other DeFi platforms in return for rewards. These rewards are usually in the form of interest, fees, or governance tokens. By providing liquidity, users enable other traders to swap tokens easily, and in return, they earn a portion of the trading fees.
How Does Yield Farming Work?
Yield farming requires users to provide liquidity by depositing two different cryptocurrencies into a liquidity pool. These pools are used to facilitate trading on DEXs like Uniswap or PancakeSwap. The first cryptocurrency is usually a stablecoin like USDC, while the second one is a volatile cryptocurrency like ETH or BTC.
When users deposit their funds into a liquidity pool, they receive liquidity provider (LP) tokens in return. These tokens represent the users‘ share of the pool and can be redeemed for the underlying assets at any time. In addition, LP tokens are used to track the amount of liquidity each user has provided, which determines their share of the rewards.
Rewards in yield farming come from different sources, such as transaction fees, trading fees, or yield farming incentives from the platform itself. These rewards are distributed to liquidity providers in proportion to their share of the pool.
In some cases, yield farming rewards may come in the form of governance tokens. These tokens give holders voting rights in the DeFi platform, allowing them to participate in the decision-making process.