DeFi is a large niche or category in the blockchain world that focuses on recreating financial institutions, but transparently on the blockchain. It removes intermediaries like banks and offers services such as lending, borrowing, and trading through smart contracts.
As an umbrella term, many different protocols fall into the category of DeFi. Popular platforms include DEXs, lending protocols, staking, cross-chain bridges, LP token staking farms, insurance protocols, stablecoins, and asset management tools.
Another popular term in DeFi is “Yield Farming”.
Yield Farming is essentially the practice of maximizing your DeFi returns by using two or more different protocols. The most common way to farm yield is to provide liquidity on a DEX which earns the user a share of trading fees and then stake the LP token in an LP staking farm, earning the user even more rewards. Another common method to farm yield is to stake ETH in a liquid staking protocol and then lend out the liquid-staked ETH token on a lending platform.
As previously mentioned, there are two popular ways to maximize DeFi Yield. Here are short guides on both.
Yield farming as a liquidity provider allows users to maximize rewards by contributing a liquidity pair on a DEX, earning trading fees, and stake the LP (Liquidity Provider) token for extra rewards. Not every liquidity pair has a DeFi farm offering additional rewards, so it's worth checking platforms like TokensFarm to see which pairs are available for farming.
To get started, a user can visit a specific DEX and provide liquidity for their chosen pair. By doing so, they will receive an LP token, which acts as a receipt for their contribution to the liquidity pool. This LP token is essential for removing liquidity in the future and allows the user to earn a share of trading fees generated by the pool.
For additional rewards, users can stake their LP tokens in a DeFi farm, where incentives are typically expressed as an APY (Annual Percentage Yield). This extra layer of earnings boosts the overall profitability of yield farming and makes it an attractive option for maximizing returns on liquidity provision.
Liquidity provision involves risks, such as impermanent loss, so users should assess the opportunities carefully before participating.
Yield farming as an ETH staker allows users to maximize their earnings by leveraging liquid staking platforms. By staking ETH on a platform like Hord, users receive hETH, a liquid staking token that represents their staked ETH along with the rewards it accrues. This means that while supporting Ethereum's network operations, users earn an APR on their staked ETH.
Liquid staking tokens like hETH are versatile and can be utilized in other DeFi protocols to amplify earnings. For example, users can take their hETH and stake it in a lending protocol where it becomes available for borrowing by other users. This creates an additional revenue stream from lending interest, effectively allowing the user to earn a yield on both the staking rewards and the lending activities.
In yield farming, APR (Annual Percentage Rate) and APY (Annual Percentage Yield) are two metrics used to measure returns, but they differ in how they account for compounding.
APR represents the annualized return on investment, excluding the effects of compounding. It calculates the percentage return a user can expect based solely on the initial principal over a year. For example, if a liquidity pool offers a 20% APR, depositing $1,000 would yield $200 over a year, assuming the rate and rewards remain constant.
APY, on the other hand, factors in compounding, which occurs when earnings are reinvested to generate additional returns. This means that APY reflects the actual annual return, assuming profits are reinvested at regular intervals. A 20% APR could result in a higher APY depending on how frequently the rewards are compounded, as the reinvested earnings continue to grow over time.
The difference lies in whether compounding is included in the calculation. APR provides a simpler view of returns, while APY gives a more accurate picture of potential earnings for users who regularly reinvest their rewards.
To start yield farming, purchase cryptocurrency like ETH from an exchange. Next, research various yield farming strategies, such as providing liquidity or staking, to determine what suits your goals. Choose a reliable platform, follow its instructions to deposit your funds, and start earning rewards from your chosen farming method.
Yield farming alternatives include long-term cryptocurrency investing, day trading, leverage trading, and futures trading. For newcomers, long-term investing is often the best choice, offering a simpler and less risky approach. Other methods require more experience and active market monitoring, making them suitable for seasoned traders seeking higher-risk opportunities.
