If you’ve been in the crypto-sphere recently, you’ve likely heard the term “yield farming.” While it sounds complex and agricultural, it is, in fact, relatively straightforward, has nothing to do with growing crops, and is one of the most valuable abilities of decentralized finance discovered so far. Yield farming is a relatively new technique used to make money with Bitcoin. Keep reading to learn what yield farming is. But first, we need to look at what decentralized finance is to understand the concept of yield farming.
First, What is Decentralized Finance?
Decentralized Finance, also known as “DeFi”, uses cryptocurrency and blockchain technologies to manage financial processes, decisions, and transactions. There are many different DeFi networks, with the two largest being Bitcoin and Ethereum. Tactically speaking, DeFi is a network of computers, often sitting in cryptocurrency mining operations in warehouses or peoples home basements. These computers run software which provides functions such as everyday banking, loans, mortgages, asset trading, and contractual relationships without any middleman humans involved in its orchestration.
The computers allow people to perform these functions and services without ever dealing with humans associated with that service. You normally have to deal with humans at traditional banks, such as Chase, Bank of America, or Wells Fargo for example. With DeFi, consumers don’t need to go ask a banker at a bank for a loan. They can simply acquire a loan from a DeFi network based upon displayed terms.
We are now in the early stages of the age of decentralized finance and DeFi is already giving rise to platforms that put consumers back in control of their finances. Because of DeFi, they are able to access terms that are much more favorable than those of standard banks that subsidize the overhead of their physical operations and by passing these added costs on to their customers. One tool for accessing these more favorable terms is yield farming.
What is Yield Farming?
Yield farming on the blockchain is a function of DeFi that makes it possible for people to earn interest or borrow capital without relying on a third party. This function allows the holders of the Bitcoin (or other crypto) to make more money from their investment. Today, many people put away their savings in an online savings account offered by a commercial bank, earning low interest rates – 0.05% or even lower – on funds deposited into the bank. If you held $25k in your savings account at that interest rate, you would earn roughly $12.50 over the course of that year.
What you should be aware of after making your $25k deposit and leaving the bank, is that they will then turn around and lend that money to another one of their customers who has requested a loan at a rate of 3% (or higher) and pockets the difference in the interest rates – in this example 2.95% – as a profit. With yield farming, people lend their savings directly to others, cutting out that 2.95% profit loss that the bank takes, allowing them to earn the full 3% return on their money. If you held the same $25k in savings for 1 year at 3% APY, you would earn roughly $750 over the course of that year.
Broadly speaking, yield farming is any effort to put crypto assets to work and generate the most returns possible on those assets. Put simply, the owners use their Bitcoin to earn money through interest. A yield farmer might move assets around on a DeFi network like Compound, constantly chasing whichever pool is offering the best APY from week to week. This is a relatively new kind of yield on a person’s deposit. Let’s take a closer look at how this works.
Earning Interest on Crypto with Compound
Compound is a protocol running on Ethereum that lets individuals and applications earn interest on their crypto without relying on third parties. People can earn interest on their crypto assets by supplying them to the protocol. Other network users can then borrow these assets and then they pay interest on the borrowed assets. All of the suppliers and borrowers who use Compound combine to form a series of Blockchain based interest rate markets.
When a person adds crypto to the Compound protocol, it gets added to a global liquidity pool which other users can borrow from by providing collateral up front. When borrowers in a specific market accrue interest, the Compound network distributes it to the original suppliers. Compound effectively allows people to participate in a decentralized money market for crypto assets, earning yield and accessing needed liquidity (a loan) whenever needed.
The Compound network represents a space where yield farmers do their work. It’s a space where you can sign up, add your crypto savings you have sitting idle to your Compound account, and start offering the assets to borrowers to earn interest.
For Example: A yield farmer might put 100,000 USDT into their Compound account. This farmer will get a token back for that stake called cUSDT. This person can then take the 100,000 cUSDT and put it into a cUSDT liquidity pool to start earning interest.
A Look Towards the Future
The future of yield farming is very bright as we have only begun to scratch the surface of what can be done in this space. There are only so many places to earn yield on your crypto assets, but new DeFi solutions seem to come online daily which bodes well for expanded use cases in the future. To give you a glimpse of this future, here are a few examples of new projects launched with this model.
A stock exchange where you can buy stocks and ETFs using cryptocurrencies recently launched and an Australian recently refinanced his mortgage using a fixed rate cryptocurrency loan on Notional Finance. Imagine getting approved for your next mortgage without ever going into an office to sign a seemingly endless supply of papers!
The power of this new tech will make current, traditional mortgage companies start to look cumbersome, eroding their core value proposition of being the quickest mortgage on the planet. Any financial situation that involves a third party has the overhead of managing humans and physical assets that comprise that business (and the profit they seek). It’s much cheaper and therefore more favorable for consumers to take advantage of a process that is less expensive to operate and more efficient.
In summary, yield farming is any effort to put crypto assets to work and generate the most returns possible on those assets. There are different ways to earn yield on your idle cryptocurrency assets with the bellwether being decentralized peer-to-peer lending platforms where people can loan their savings directly to borrowers, reaping the full rewards often enjoyed by commercial banks. Cryptocurrency and blockchain enthusiasts should be on the lookout for new yield farming solutions that come online to further diversify their yield activities and reap better returns as the market fluctuates.
About the Author:
Tim Duncan is the Growth Practice Lead at Bottle Rocket and is an active thought leader on digital product growth in the marketplace. Duncan is an integral part of Bottle Rocket’s team of experts, helping clients to modernize their approach to building loyal, profitable, mobile experiences.