The previous lesson described the inner workings of liquidity mining, a popular method of using existing crypto assets to earn more crypto by providing liquidity to decentralized exchanges. Aside from liquidity mining, DeFi also offers another yield product: yield farming.
Yield farming arrived alongside governance models during summer 2020. As more developers focused on expanding DEXs and improving their level of decentralization by delegating the decision-making process to the community, a unique yield product was born. Yield farming is essentially the same as liquidity mining, with the core difference being that farmers additionally earn LP or governance tokens.
Each decentralized DeFi project has a unique governance model. The utility of that model is derived from the use of governance tokens. A person who provides liquidity to a DEX with a governance model not only earns fees but governance tokens as well.
Alternatively, the protocol will grant LP tokens - a token representing a user’s share in the liquidity pool. LP tokens are ERC-20 tokens and are held in the wallet of the contributor, which means that they can be actively used on other DeFi protocols. The end result is that one can maximize his profits by farming existing crypto assets and farming new LP tokens as well.
Another major point that must be noted is that yield farmers behave aggressively in the crypto market. To earn the best rewards and stay competitive they are forced to constantly chase liquidity pools with the highest APY rate.
This fervorous activity led to the creation of yield farming aggregators, protocols that allow farmers to participate in the best LPs all from one spot. A notable example of a yield farming aggregator is Yearn Finance, the popular DEX built by famous DeFi developer, Andre Cronje.
Similar to liquidity mining, yield farmers also suffer impermanent loss - the difference being that the risk is far higher if farmers decide to farm LP tokens as well.
A simpler way of understanding yield farming and its increased complexity is via a step-by-step guide. We have used MetaMask as an example so make sure to read our How to use MetaMask guide if you need help. Here are the eleven steps that you must take to farm:
Yield farming is practically the same deal as liquidity mining. However, there are a few key differences that might pose a deal breaker when deciding between the two. To summarize:
Based on their difficulty, we recommend the following yield farming protocols.
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