The DeFi (Decentralized Finance) space lately has been filled with people talking about earning passive income by holding or lending digital assets. As a result, many new to the space are left with questions like what is crypto farming and why do we have to harvest digital coins?
If you’re new, none of these concepts have to do with physically planting or harvesting a crypto. Crypto farming or yield farming crypto is simply a way you can earn passive income just by holding or lending digital assets.
The idea of earning money on your idle digital assets has attracted a lot of people to crypto farming. While the returns are exciting, you need to understand how it works, the risks, and the best places to farm crypto.
What is Crypto Farming? Definition
Image credit: Binance
Crypto farming involves staking or lending crypto assets in a decentralized finance protocol to earn high returns or rewards in the form of further cryptocurrency. Imagine it as a high-yield savings account, without the bank.
With a conventional bank, you deposit money in an account, and the bank will lend to other people, while you will be given a small portion of the interest. When it comes to crypto yield farming, you skip the middleman. You give your assets to a platform that requires them to operate. In return, you receive a greater portion of the interest.
How Does Crypto Farming Work?
To understand how does crypto farming work, you have to look at decentralized exchanges (DEXs). In contrast to Coinbase or Binance, which rely on order books to pair buyers and sellers, DEXs such as Uniswap rely on a Liquidity Pool.
When you deposit money into a DEX or other DeFi platforms, it is added to the liquidity pool. The platform uses the funds in the liquidity pool to give loans, trade, and provide other services. In return, every member of the liquidity pool earns rewards in crypto.
Liquidity Providers (LPs) and Liquidity Pools
Image Credit: Binance
Liquidity Providers (LPs) are simply people who deposit money into a liquidity pool for crypto farming. You place two tokens (typically in a 50/50 ratio, such as ETH and USDC) into a smart contract called a liquidity pool.
Other users then use this pool to swap their tokens. Whenever they engage in a trade, they pay a little fee. This fee is shared between all the LPs in the pool according to their proportion of total liquidity.
Earning Yields and Governance Tokens
The fees are only one way you get compensated. Many platforms also give farmers yield in the form of their governance tokens to attract more liquidity. These are the native coins on the platform (such as UNI, SUSHI, or CAKE).
This is why in addition to earning yields, it is said that you are earning a share of the protocol itself. These tokens may be traded or used to vote on the future of the project. Investors often check the coin price prediction of governance tokens before deciding to hold or sell them.
How Are Yield Farming Returns Calculated? (APY vs. APR)
Image Credit: TabTrader
In addition to fees and governance tokens, if your crypto is used for lending, you’ll earn additional interest. You will come across two acronyms when you consider yield farming crypto returns: APR and APY.
- APR (Annual Percentage Rate): This is the simple rate of interest. If you invest $1,000 at 10% APR, you’ll have $1,100 at the end of the year.
- APY (Annual Percentage Yield): This is with compounding. When you reinvest into the farm what you get each day in the form of rewards, then your interest earns interest.
What this means is that a 10% APR = 10% yearly return, 10% APY = higher returns due to compounding rewards. APYs can typically range from 7-20%.
Popular Crypto Yield Farming Platforms
If you’re ready to start crypto farming, you’ll want to start with the top platforms first. These are most battle-tested protocols in the industry:
- Uniswap: The king of Ethereum-based decentralized exchanges. It offers high liquidity and V3/V4 concentrated liquidity models where users can earn yield.
- PancakeSwap: The cryptocurrency farming platform of choice on the BNB Chain (with lower fees).
- Aave: One of the most popular lending and borrowing protocols, in which you can earn yield by lending out your assets.
- Curve Finance: Curve is optimized to farm stablecoins, which have a lower risk and more stable returns.
Crypto Farming vs. Staking: What’s the Difference?
The concept of farming in crypto is often confused by newcomers with staking. They both make passive income, but they are different altogether.
Staking typically entails a single coin (such as SOL or ADA) being locked in order to aid in securing a Proof-of-Stake blockchain. It tends to be less risky and has lower and less volatile returns.
Crypto Farming is the act of transferring assets between various pools and protocols in search of the highest yield. It is more complicated and has several tokens that are involved and has more risk but has a lot more rewards.
The main differences between staking and DeFi yield farming lie in their purpose and risk profile. Staking is often long-term and done to secure a blockchain. Crypto farming is an active strategy used to provide liquidity to decentralized finance (DeFi) platforms for higher potential returns.
What is Crypto Airdrop Farming?
Airdrop farming is not like the usual yield farming where you get an amount of interest. In crypto airdrop farming, users engage with new protocols that have not been launched in the hope of earning free tokens when the project ultimately launches.
Crypto airdrop farmers will swap funds to a new network or trade on a new DEX, in order to establish a transaction history. Their rewards are based on this transaction history. When the project launches, they receive the tokens via airdrops. It’s a growing trend, and
The Risks of DeFi Yield Farming
Even though the yield can be very attractive, DeFi farming is not without risks. What you are doing is essentially being your own bank and that means there are a number of things that can go wrong. The main risks involved in DeFi yield farming include:
- Impermanent Loss: This is the most common risk involved in DeFi yield farming. It occurs when the price of the tokens that you deposited is vastly different from when you deposited them. You might end up with less value than if you had just held the coins in your wallet.
- Smart Contract Vulnerabilities: DeFi is code-based. In case such a code contains a bug, hackers may drain the liquidity pool, leaving the farmers with nothing.
- Rug Pulls: Sometimes, scam developers will launch a new farm with a 10,000% APY-shining, get people to deposit funds to it, and vanish with the funds.
- Gas Fees: On the Ethereum blockchain, transferring funds in and out of farms may be costly. The transaction fees (gas) may devour all your earnings otherwise.
How to Farm Crypto: A Quick Guide
If you want to know how to farm crypto, follow these basic steps:
- Set up a Wallet: Download a non-custodial wallet like MetaMask or Phantom.
- Buy the Crypto: Buy the tokens you want to farm (e.g., ETH and USDT) on an exchange and send them to your wallet.
- Choose a Platform: Connect your wallet to a trusted platform like Uniswap or PancakeSwap.
Source: Uniswap
- Deposit Liquidity: Enter a “Pool” and deposit your token pair. You will receive LP tokens in return.
Source: Uniswap
- Stake LP Tokens: Often, you need to take those LP tokens and deposit them into a “Farm” tab on the site to start earning the governance tokens.
- Harvest Your Rewards: Periodically click “Harvest” to claim your earned tokens.
Conclusion: Is Cryptocurrency Farming Worth It?
Cryptocurrency farming is among the most effective wealth creation tools in the digital space. It’s a great way to earn interest without being a crypto day trader chasing coin price predictions. It enables you to be part of the development of a project without actively being involved.
However, it requires constant education and a healthy dose of caution. Begin with little on reputable platforms and never invest anything you cannot well afford to lose. Crypto farming is a great passive income opportunity, but it’ll take a competent farmer. Spend the time it takes to become one.
FAQs About Farming Crypto
What is crypto farming for beginners?
It is a means of earning cryptocurrency rewards through lending your existing coins to a decentralized protocol.
Is yield farming crypto safe?
It is riskier than owning crypto in a wallet. Smart contract bugs, market volatility, and impermanent loss are among the risks. If you choose a trusted platform, these risks are greatly reduced.
How much can I earn with crypto yield farming?
Returns vary wildly. The APY of stablecoin farms can be as high as 5-10 percent, whereas newer, more risky, degen farms can be above 100 percent.
How often should I harvest my rewards?
Fees should determine when you harvest rewards. With low fees, you will be able to harvest and compound on a daily basis. When the fees are high, you can possibly wait until your earnings greatly exceed the price of the transaction.
Can I lose my money in yield farming?
Yes. In case of a platform hack, the reward token value plummets or in case of a significant impermanent loss, you can lose most or all your money.
How to farm crypto without high fees?
Find DeFi applications on the Layer 2 networks such as Arbitrum or Base, or fast, high-throughput blockchains such as Solana, where the transaction fee is typically less than one cent.
