Yield Farming Guide

Market Meditations | April 5, 2021

Yield Farming 101

We’ll say it right from the start: this segment is NOT for the faint of heart. One of the many benefits of a crypto bull market is that those who have spent the time and energy to study and apply their knowledge can compound their profits using highly complex and innovative strategies, one of which is known as yield farmingMarket Meditations has done this hard work for you. In this article, we’ll explain what yield farming is, reveal a step-by-step tutorial with examples to help you get started, and elaborate on the risks involved. Is it easy? No. But with the right knowledge, this is a once in a lifetime chance to seriously increase your gains ?

What is Yield Farming?

Yield farming is a strategy that allows you to lend your crypto via decentralized protocols in exchange for rewards. You lend funds through a smart contract rather than a middleman like a bank. Different protocols and yield farming strategies generate different returns and rewards are changing by the minute. By constantly monitoring different protocols and testing new strategies, you can deploy your capital against the protocol and strategy that pays you the highest reward at that moment. The most convenient way for a beginner to maximise profit and minimise frustration is to use a platform that aggregates different lending protocols and automates yield farming strategies. Let’s take a look at a step by step example on how to get started.

Step By Step Example: How To Deposit

1️⃣ You’re currently holding 50 ETH on FTX.

You’re a beginner looking to take advantage of yield farming to increase your profits during the bull market. What’s next?

2️⃣ Find an aggregator lending protocol that allows you to deposit crypto like ETH into liquidity pools and earn rewards.

Liquidity pools are smart contracts that allow individuals to borrow, lend, or exchange tokens without middlemen. We’ll use Rari Capital as our example of an aggregator lending protocol for demonstration purposes only. Rari is NOT a sponsor of this newsletter.

  • Navigate to https://www.rari.capital/, click “Launch Portal.” Other platforms may ask you to “Launch App” or “Go to Vaults.” All you’re doing is launching the application that will allow you to lend your crypto.
  • Next, connect your wallet. Connecting your wallet does NOT give the portal access to your funds. It simply allows you to deposit funds into the pool and withdraw profits to the wallet. When using decentralised pools, you don’t need to sign up for an account, submit an email address, or choose a username. Your wallet address becomes your identity and no KYC is involved. Many choose to use Metamask as their wallet.
  • Select the pool of your choice you’d like to lend to. Rari, for example, has an ETH pool that, at the time of writing, pays out 21.15% APY. The APY is constantly changing based on the supply and demand for ETH in the pool. Pools across different protocols are often named after the coin to deposit (e.g. deposit BTC into a BTC pool, USDT into a USDT pool, etc).
  • Click “access pool” (or another variation of this wording). Select the amount of ETH you’d like to deposit (e.g. 20 ETH) and confirm the transaction. That’s it. You deposited 20 ETH into the ETH pool and are now earning 21.15% APY. If the APY changes, so do your rewards.

Step By Step Example: How To Earn Rewards & Withdraw Profits

Here’s where it can get a touch complicated. When the bank lends out your USD, they pay you interest in USD. With yield farming, however, your rewards are often paid in the platform’s native governance token, not in the asset you deposited. Let’s walk through a step-by-step to help you interpret this:

  • You deposited 20 ETH into the pool. You no longer have access to this ETH until you withdraw, because the aggregator is using it to generate yield with its strategies
  • What you do have is a verifiable transaction on the blockchain that states that the protocol owes you 20 ETH. In order to represent the 20 ETH the protocol owes you, a smart contract sends you the platform’s governance tokens in the amount that equals the total value of ETH you deposited. For example, 20 ETH = 3,224 RGT (Rari’s governance token) at the time of writing, so when you deposit 20 ETH, Rari sends you 3,224 RGT. Let’s make this even simpler.
  • You originally had 50 ETH in your Metamask. You deposited 20 ETH into the Rari ETH pool. You now have 30 ETH in your Metamask and 3,224 RGT that you may redeem for 20 ETH at your leisure. In exchange for lending your ETH, Rari pays you 21.15% APY in RGT.
  • When you’re ready to cash out, simply click “withdraw funds” and the smart contract will convert your RGT back into 20 ETH. You may also “claim” the interest paid out in RGT and immediately convert it into another crypto or stablecoin or reinvest into another pool to earn even more yield and compound profits.

Aggregators like Rari optimise yield by leveraging different DeFi protocols to maximise your profits automatically by implementing strategies that will generate the most yield that moment, switching between strategies in real time. You don’t have to use an aggregator. You can always create strategies yourself and monitor different protocols on your own, but the tradeoff is time, convenience, and expertise.

Risks & How To Protect Yourself

Yield farming is high risk, high reward. If you’re not careful, you can lose your funds. Unlike centralised platforms, there is no customer support to recover your money. Let’s look at some things you need to be aware of if you’re considering yield farming:

1️⃣Smart Contract Bugs:

  • Risk: Yield farming is controlled by smart contracts that remove all middlemen. Hackers can introduce bugs into the computer code and if done successfully can rob some or all of your funds.
  • Action Item: Diversify your yield farming strategy by leveraging different protocols and make sure every protocol you’re using has been audited. Do not yield farm with 100% of your portfolio.

2️⃣Impermanent Loss:

  • Risk: this is an event in which a liquidity provider has a temporary loss of funds because of volatility in a trading pair. The higher the volatility of the asset(s) you deposited, the bigger the loss of funds.
  • Action Item: Provide liquidity with coins that do not have big price fluctuations (e.g. stablecoins). This allows you to benefit from the rewards without worrying as much about impermanent loss.

3️⃣User Error:

  • Risk: It can take time for beginners to adjustto theuser interface of platforms and because of the decentralised nature of such protocols, there is very little room for error. Even simple mistakes like clicking the wrong button or pop-up can cost you big.
  • Action Item: Start small and test to get comfortable. Be patient. Prioritise your education (we’ve listed some resources for you at the end of this article).

4️⃣Security Flaws:

  • Risk: It’s very easy for someone with malicious intent to hack into your systems if you fail to set up proper security. Defence softwares and VPNs are just the beginning.
  • Action Item: Read our 9 Step Essential Cryptocurrency Security Guide to make sure you’re up to speed.

For a complete list of decentralised protocols and aggregators Koroush AK uses, read our Passive Income Guide.