How To Yield Farm

First off we must address the fact that yield farming is a high risk and volatile investment strategy. I love it, but that doesn’t mean it’s easy or even should be done. Yield farming is essentially depositing crypto-assets into a pool in which you earn rewards from people swapping between those two assets. An easier way to think about it is, imagine if you were Coinbase, and you were facilitating buy and sell orders on Bitcoin for a fee. Uniswap is currently the largest decentralized exchange by volume.

There are a bunch of ways you can yield farm and there are even some advanced strategies to earn upwards of 50% apy on assets. Today I’ll be walking you through, what yield farming is, some of the basic concepts to know, and how you can get started yourself.

What is Yield Farming?

I didn’t want to write some B.S overview article without showing you a true Uniswap v3 position. The black bars are there just to hide the address associated with this position for security, but who knows, it’s insane what hackers can do nowadays.

Anyways the important parts to note here are that I provided $247.69 as “”Liquidity”, which is my own money. The “Unclaimed fees” part is what I have earned from people buying and selling BTC or Bitcoin, which can be collected whenever I want.

How To Claim Fees or Rewards?

In the image above if you click the “Collect fees” button, you would then accept a smart contract transaction that would pay your rewards out to you.

Smart Contract Gas Fees

Every time you perform an action on the blockchain you will incur a gas fee. Depending on the network this gas fee can be extremely cheap or extremely expensive. As an example the average gas fees on the polygon network are $0.01 cent. On Ethereum it can be as high as $100. Polygon is a L2(Layer 2) on Ethereum which is why the fees are a lot cheaper.

Concentrated Liquidity

That is the very top level view of what is happening when someone is yield farming. To add one more little piece to this without confusing you too much too early. Uniswap V3 allows you to concentrate your liquidity between price points that you define. This allows you to earn more fees from your position. It essentially means earn fees from swaps that fall into this price range. If the price goes to far down or up your position will be dumped into a single token.

Lastly, there are other things which could be considered yield farming, like depositing your funds(BTC/ETH) in Aave(DeFI banking protocol) and they pay not only fees from lending out your assets, but also you could be paid token incentives if there are some. An example of this was when Matic(POL/Polygon) was offering rewards for depositing and borrowing on the Polygon Network. You heard me right, people where getting “Paid To Borrow”. You could also borrow against your collateral in Aave, borrowing USDC/DAI(Stablecoins) and then use those to provide liquidity on Uniswap, while your BTC/ETH increases in value.

Risk Of Yield Farming

Yield farming has a lot of pitfalls. I don’t say that to scare you away, but to truly inform you that yield farming is not for the faint of heart. There are risks in lending, borrowing, and even providing liquidity to decentralized exchanges. I’ll explain each one below.

Lending

This is probably the least risky of all 3 but it still is extremely risky. Lending your crypto assets to a lending protocol like Aave has risks. First one being liquidations, so if you provide Bitcoin as collateral, someone could borrow that bitcoin and not pay the loan back. If they don’t or their collateral falls below the amount needed to keep the loan open, the protocol will auto-liquidate their position.

The problem with this is that whatever they provided could be worth a lot less than the bitcoin they didn’t pay back. In Aave’s defense, they have done a lot of work to improve protocol parameters and so far they have been running mostly without a hitch for 3-4 years. They’ve also added notifications for users who are close to liquidation and use their own token “Aave” to help in case of stability issues which will be sold from the staked supply to help pay users back.

Borrowing

Borrowing is “extremely risky”. The reason I put that in quotes is because I have learned from experience the hard way on this one. The health factor from Aave above shows how close you are to liquidation. The second image is warning that Aave shows when borrowing so much that your health factor drops below (1.5).

Borrowing’s risks lie in two main components, your collateral, and what you borrow. An easy example of this is depositing bitcoin and borrowing USDC(stablecoin) against it in Aave. The value of the amount you borrowed is stable because it is a stablecoin, but your deposited Bitcoin’s price is volatile. So imagine Bitcoin goes from 60k to 15k. The amount of collateral you have drops substantially thus auto-liqudating your position. In that case you lose everything you deposited into the platform.

Smart Contract Flaws

Smart contracts are not perfect. While the dapps mentioned in this article have been heavily tested and audited, the crypto space is still fairly new and evolving. There have been a lot of bugs that have caused a lot of money to be stolen over time. There is also what is called “Getting Rugged” in which the developers themselves either dump their dapp token on the market forcing the coin down or a smart contract bug causes liquidity to be drained.

Liquidity Providing

LP’ing or Liquidity Providing is also risky. So I mentioned uniswap v3 allowing users to set at what price points they want to provide liquidity. You can also tell Uniswap that you want provide liquidity for the entire price range. Liquidity providers face what is known as impermanent loss. I figure this one would be better with a visual example. The below image shows what would happen if you provide liquidity for the BTC/USDC pair when bitcoin is at $37,650, and then price of bitcoin falling to $29,000. If you put $1000 dollars into a liquidity pool and the above scenario happens, then your LP position would now be worth $877.64 which would be a loss of $123.

Regulatory Risks

This one is a bit tricky, because currently there are tools to calculate your taxes and what you owe the IRS or whatever government you pay taxes too. The issue with this specifically in the U.S is there really isn’t any regulatory clarity on crypto. Meaning that the conditions and what is valid and isn’t valid is rapidly changing. Do your best to stay up to date on your governing body’s tax laws and crypto laws.

What Do I Need To Yield Farm?

You need 3 things

• A web3 wallet/digital wallet an example would be MetaMask
• Cryptocurrency in your web3 wallet
• LP tokens that you have bought and staked on a decentralized exchange

Add Liquidity Screen On Uniswap

You will also need to make sure that you have thought about your taxes. There are plenty great resources out there that explain/help with preparing your crypto tax gains. I can’t stress this part enough as many people forget that regardless there are only two things guaranteed in life, death and taxes.

What Is Decentralized Finance or DeFi?

Decentralized finance is exactly what we have been discussing throughout this article. DeFi is against the idea of a centralized financial system. It allows users to bring their own liquidity on which users can buy, sell, and transfer assets.  DeFi essentially allows the masses to become market makers and do what banks do. It also eliminates the unnecessary fees charged by big banks that people pay to do just about anything.

What are Dapps or Decentralized Apps?

Dapps are applications that run on decentralized blockchains. The key point is there is no single point of failure like there is with large banks or corporations. Dapps can also power things unrelated to finance such as gaming, shipping, digital identity, and social media.

Final Thoughts

I think getting into DeFi can be fun and teach you a lot about blockchains and smart contracts. It can also teach you a lot about how financial markets work. With that being said it is extremely risky and cryptocurrency prices are super volatile. You are likely to lose a lot of money. If you are going into DeFi with money that you can afford to lose and you have a lot of time to get through the learning curve it can definitely be exciting.

Disclaimer

Disclaimer: The information provided in this blog series is for informational and educational purposes only. I am not a financial advisor, and the content presented here should not be construed as financial advice or recommendations for making investment decisions. Crypto investments, especially in the decentralized finance (DeFi) space, carry inherent risks.

I do not endorse or guarantee the accuracy, completeness, or reliability of any information presented in this blog series. Any actions you take based on the information provided here are at your own risk, and I shall not be held responsible for any losses or damages that may occur as a result.