What is Yield Farming? – Forex News by FX Leaders

Yield farming is basically a decentralized finance (DeFi) investment strategy that optimizes your existing cryptocurrencies by investing them in places that offer higher interest rates than traditional financial instruments. 

The term “yield” is another way of saying “interest” or “returns”, or in other words, the money you get for investing in any financial instrument. “Farming” on the other hand, equates investment and financial growth with how crops are grown on a farm. Combined, “Yield Farming” means looking for the highest interest-yielding financial instrument that would help you grow your cryptocurrency portfolio through passive income.  

How does yield farming work?

There are five possible ways to do yield farming. 

1. Liquidity Providers

This is a process by which an investor lends capital or “liquidity” to a decentralized exchange for a period of time. In turn, the exchange collects small transaction fees from each transaction made on their platform, and a portion of this is given to the investors that initially lent them their cryptocurrency, in the form of interest, in return for providing the capital. This is commonly done by providing liquidity pairs to the exchange (example: AXS/BNB, CAKE/USDT, ADA/BUSD). 

2. Lending

Firstly, certain cryptocurrency lending platforms offer rewards to anyone who lends their cryptocurrency to them. They offer considerably higher yields for deposits than most traditional banks do. 

3. Borrowing 

Borrowing, also known as “crypto-backed loans” is the exact opposite of lending.  For example, you initially have Bitcoin (BTC) in your wallet. Some platforms allow you to borrow or take out a loan with your Bitcoin (BTC) as collateral. (Take note that most crypto-backed loans are overcollateralized.)

Why would you do this? Well, if you believe that the price of Bitcoin (BTC) will go up, you can lock it up as collateral, so that you can take out a stable coin loan. You can then use the stable coin money for other investments, while your Bitcoin remains locked up, as it appreciates in value. Then, when you are ready to redeem your Bitcoin (BTC), all you have to do is to return the borrowed stable coins, and you get your original locked-in Bitcoins back, plus the additional appreciated value. This is another form of yield farming.  

4. Staking

Staking is the process by which you are also able to gain rewards on cryptocurrencies that you own, specifically those that use the proof-of-stake model for validating and processing their network transactions. 

Staking involves creating a staking node, which is very technical to set up. As a solution to this, several cryptocurrency exchanges, like Coinbase and Binance, offer staking services. They do the staking node setup, while you provide the capital for the staking. Yields are smaller than if you set up the staking node yourself, but this service offers great convenience for anyone who is not technically savvy enough to set one up…