Yield Farming: A thread 🧵
Since DeFi summer, yield farming has become a past time for apes, degens, and serious crypto investors Â
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While some of the stigma associated with rug pulls remains, we would like to understand the fundamental exchange of value that yield farming entails
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While some of the stigma associated with rug pulls remains, we would like to understand the fundamental exchange of value that yield farming entails
Yield farmers support five types of activities:Â
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Operating the networkÂ
Lending to tradersÂ
Providing liquidityÂ
Managing protocolsÂ
MarketingÂ
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Farmers are compensated for these through the issuance of protocol tokens or interest earned on their positions
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Operating the networkÂ
Lending to tradersÂ
Providing liquidityÂ
Managing protocolsÂ
MarketingÂ
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Farmers are compensated for these through the issuance of protocol tokens or interest earned on their positions
What exactly is yield farming? At its purest form, it is: the managing of passive strategies to earn well-defined payouts on cryptocurrency positions
Passive? Of course, yield farming is hard work. But unlike running a validator or managing algorithmic strategies which require ongoing technical labor, yield farming requires minimal interactions after the initial decision making process
And the presence of well-defined payouts distinguishes yield farming from simple buy-and-hold strategies, which hope for future price appreciation, rather than clear rewards, emissions, or interest
With definitions out of the way, let’s cover the main activities that yield farmers support – that is, the types of value they create in exchange for compensation
First, the most basic function in crypto is correctly and securely operating the network Â
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This is done by validators, who process transactions reliably and honestly. Many networks ask validators to post collateral that can be seized if the validator underperforms
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This is done by validators, who process transactions reliably and honestly. Many networks ask validators to post collateral that can be seized if the validator underperforms
So the first major form of yield farming is for farmers to delegate their capital to high-quality validators in exchange for a percentage of the payments that validators receive
Delegating one’s coins to a low-quality validator can lead to slashing risks like forfeited capital, which would directly penalize the delegating farmer
By delegating to reputable validators, farmers are creating value for the network by contributing to its security
Second, popularized by DeFi Summer in the mid-2020s, lending has become one of the most common forms of yield farming Â
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Instead of lending their coins to validators, farmers are able to deposit their tokens into DeFi pools to lend to traders
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Instead of lending their coins to validators, farmers are able to deposit their tokens into DeFi pools to lend to traders
By lending, farmers generate economic value for capital-constrained traders in exchange for compensation from those borrowers
Third, providing liquidity has become a sought after tool for a yield farmer’s arsenal Â
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Before DeFi exploded, only centralized exchanges and professional market makers had the capital and technical expertise needed to provide liquidity
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Before DeFi exploded, only centralized exchanges and professional market makers had the capital and technical expertise needed to provide liquidity
Thanks to automated market makers (AMMs), farmers can deposit cryptocurrency positions into liquidity pools and passively earn yield. But farmers take the risk of capital losses if the exchange rate moves against them!
So farmers take on these risks and provide liquidity in exchange for trading fees and any rewards that are issued in the AMMs native token, and this is yet another way they provide value to the crypto ecosystem
Fourth, moving beyond providing liquidity, farmers can earn yield by powering pooled systems that manage tokens in passive and delegated ways
We see this with @ConvexFinance which directs liquidity across liquidity pools on @CurveFinance, and in @iearnfinance which allocates assets across multiple lending and liquidity protocols
By engaging in protocols that build on top of each other, farmers can create surplus through more efficient token management, while also decreasing transaction costs from using automated portfolio management tools
Sometimes, though, managing involves value extraction rather than creation – especially when farmers participate in the bribing economy, which allows them to cast specific votes in exchange for payments. Still good for yield farmers, but less surplus for the ecosystem
Fifth and finally, yield farming acts as a tremendous marketing tool for protocolsÂ
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The more total value locked (TVL) in a protocol, the more attention and trust it earns, and the more likely it is to become the default choice for farmers
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The more total value locked (TVL) in a protocol, the more attention and trust it earns, and the more likely it is to become the default choice for farmers
TVL can also influence a protocol’s perceived valuation with TVL multiples commonly cited in a similar way web 2 companies use price to earnings and sales multiples
Therefore, the final value yield farmers provides is enhanced visibility and trust through asset allocation Â
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As a way to reward farmers for taking risks and boosting TVLs, protocols offer large emissions and rewards down the road
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As a way to reward farmers for taking risks and boosting TVLs, protocols offer large emissions and rewards down the road
But despite a lot of different methods and risks, yield farming at its core is a simple concept:Â
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Farmers passively provide value to protocols in exchange for direct and indirect compensation
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Farmers passively provide value to protocols in exchange for direct and indirect compensation
Yield farming is not an easy business that comes free from risksÂ
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Although the concept is easy to understand, farmers should be well-versed in the risks associated with smart contracts and financial movements
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Although the concept is easy to understand, farmers should be well-versed in the risks associated with smart contracts and financial movements
But over time, we think these risks can decrease – and will deliver on crypto’s broader promise to democratize finance and allow anyone to provide these core sources of value
You can read the full piece here:Â jumpcrypto.com
Did we miss anything? Let us know @sansgravitas @theshah39
Did we miss anything? Let us know @sansgravitas @theshah39
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