According to coinbase, DeFi (or “decentralized finance”) is an umbrella term for financial services on public blockchains, primarily Ethereum. With DeFi, you can do most of the things that banks support — earn interest, borrow, lend, buy insurance, trade derivatives, trade assets, and more — but it’s faster and doesn’t require paperwork or a third party. As with crypto generally, DeFi is global, peer-to-peer (meaning directly between two people, not routed through a centralized system), pseudonymous, and open to all.
Yield farming is an application of DeFi. This is lending or staking your cryptocurrency so you can get reward from it. This is somewhat almost like earning interest from a bank account;. Only yield farming are often riskier, volatile, and sophisticated unlike putting money in a bank.
How does Yield Farming Works
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.Put simply, it is an income opportunity by lending your tokens through a decentralised application (dApp). The lending happens through smart contracts with no middleman or intermediator.The liquidity pool powers a marketplace where anyone can lend or borrow tokens. The usage of these marketplace incurs fees from the users, and the fees are used to pay liquidity providers for staking their own tokens in the pool.
The interest in an yield farm investment is calculated in two ways: APY - Annual Percentage Yield (interesting rate including compound interest) and APR - Annual Percentage Rate (interest rate exluding compound interest)
Yield Farming Platforms
There are various yield farm protocols used by yield farmers to stake and earn interest from their cryptocurrency.Listed below are some of these platforms.
Compound Finance
Compound is an open source protocol built for developers that uses an algorithmic, autonomous interest rate protocol to determine the rate depositors earn on staked coins.
Curve Finance
Curve is an exchange liquidity pool on Ethereum designed for: extremely efficient stablecoin trading, low risk, supplemental fee income for liquidity providers, without an opportunity cost.
AAVE
Aave is an Open Source Protocol to create Non-Custodial Liquidity Markets to earn interest on deposits and borrow assets with a variable or stable interest rate. The protocol is designed for easy integration into your products and services.
Uniswap
Uniswap is a decentralized exchange (DEX) where liquidity providers must stake both sides of the pool in a 50/50 ratio. In exchange, you earn a portion of the transaction fees plus UNI governance tokens.
Conclusion
Yield farming involves staking, or locking up your cryptocurrency in exchange for interest or more crypto. While it's possible to earn high returns with yield farming, it is also incredibly risky. A lot can happen while your cryptocurrency is locked up, as is evidenced by the many rapid price swings known to occur in the crypto markets.
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