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Liquidity Farming

Updated on Wed, 7 Feb, 2024 at 8:32 PM


What is Yield Farming?

Yield farming is a practice in the cryptocurrency industry in which users provide liquidity to a decentralised funding protocol (DeFi) in exchange for a reward in the form of tokens;

Liquidity is provided through the provision of funds in a liquidity pool, which is a shared fund that allows users to exchange different tokens without the need for a centralised exchange;

In return for providing this liquidity, users receive a share of the transaction fees generated by the liquidity pool and often receive additional protocol tokens as a reward;

The aim of yield farming is to increase liquidity and activity in a specific DeFi protocol and, at the same time, allow users to earn rewards by participating in the DeFi ecosystem.

What is the difference between Yield Farming and Staking?

Yield Farming can sometimes be very similar to Staking, but the latter involves supporting a blockchain by participating in the validation of transactions by contributing cryptoassets to the network;

Blockchain networks that employ the Proof of Stake (PoS) method for validation consensus use Staking. Validators earn rewards while waiting for block rewards to be released. 

Between Yield Farming and Staking, the latter is the simplest strategy for earning rewards. Participants can decide the staking pool and lock their assets. In contrast, Yield Farming requires participants to choose the tokens and platforms on which to lend, with the added complexity of switching platforms and tokens;

Liquidity Farming is also the riskiest strategy, with the potential for rug pulls, smart contract errors and volatility losses, but it can result in annual percentage returns of 1% to 1,000%.

Where can Yield Farming be done?

Platforms where Yield Farming can be done can be decentralised or centralised. These platforms allow users to earn rewards for lending their assets within these platforms. These rewards are generated automatically through liquidity supply, which allows users to accompany and support blockchain projects.

Main risks of Yield Farming

  • Exchange riskwhen digital assets are exchanged, there is a risk that the price of the asset may change significantly, which could result in losses for the contributor.
  • They are difficult to use and highly technical platformsif a person does not have basic knowledge of financial tools, he or she may find him or herself in a very wide linguistic and technical limbo.
  • Security of smartcontracts: if the platform has not been properly audited, there is a risk of theft of funds and partial or total loss of funds.

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