Yield farming is simply the practice of locking up cryptocurrency tokens in a liquidity pool in exchange for rewards. This pool is designed and controlled by smart contracts that remove the need for a third party thereby improving trust between the DeFi application and the yield farmer. Imagine it as taking your money to a bank to keep in a fixed deposit account over a period of time and earning interest on that deposit over the agreed period of time. Also called Liquidity mining, the general idea behind yield farming is that people are able to earn tokens in return for their participation in applications on the DeFi space. The present frenzy started in June 2020, when Ethereum-based credit protocol Compound started distributing it’s COMP governance token to the people who use the Compound application to lend and borrow. It instantly became a hit and moved Compound into a top position in the DeFi ecosystem. In that summer of 2020, the founder and managing director of CoinFund, Jake Brukhman spoke of the opportunities the investment venture holds. He said, “I’m seeing opportunities that range from a few points of APY to over 100% or even several hundred percent APY, depending what assets you hold and what risks you’re willing to take. Most of the returns come from exuberance or inefficiency of these early protocols.” He went on to say, “A lot of the lending facilities are currently offering capital at very low rates (sometimes 0%) relative to the APYs one could be earning.” The craze of yield farming even reached the music industry with Grammy award-winning music producer and artist André Allen Anjos, also known as RAC, catching the bug. He spoke of how his irregular time schedule as a music-maker had afforded him the hours he needed to explore yield farming. “I’m obviously a musician,” he said. “That’s what I do full time. Because of my job, my day-to-day is pretty loose. I can kind of do whatever I want. You pull up Twitter and everyone’s freaking about Yams,” Anjos said, referring to a DeFi yield-farming project that blew up in popularity in August of 2020. Fast forward to the present day and following the success of COMP, there are several projects that have followed the “yield farming format” set by Compound, by creating DeFi applications that come with their native or governance tokens and rewarding users who lock up a percentage of these tokens. Typically, farmers stake stable coins like Tether (USDT), USD coin (USDC) or DAI because they are easy to track and measure profits and losses but it is also possible for yield farmers to stake using cryptocurrencies such as Ethereum (ETH). Applications for lending and borrowing like Aave and Compound at the lowest level offer 6.2% and 4.6% interests respectively on USDC deposited. There are many more sophisticated yield farms like Yearn for example that are generating as much as 7.8% using their basic yield strategies, and as high as 16%, with the use of their more aggressive strategies. Benefits And Risks of Yield Farming Like with everything where there are benefits, there are also risks, you know, pros and cons. The main benefit of yield farming is profit. Yield farmers who get into a new project early can benefit when the tokens they hold increase in value quickly. These tokens increase in value because a lot of people begin to adopt them and the early guys in the farm make maximum gains because they rode the trend from the get-go. They can sell their tokens at the appropriate time and make really good gains. They can also go ahead to reinvest their gains in other projects and farm for more yields. A major risk yield farmers run is the risk of liquidation. Because of the volatile nature of Cryptocurrencies and tokens in the DeFi space and farmers having to stake hundreds of thousands of dollars to generate significant profits. Farmers risk being liquidated if there’s a significant drop in the market. There’s also the risk of suffering impermanent loss. If the price moves too much in a liquidity pool, liquid suppliers can actually lose money. It is important that providers of liquidity understand the concept of impermanent loss and you can read more about it here. Impermanent Loss as shown on Uniswap – source: Uniswap documentation How Formation Finance Solves These Problems All of the craziness and risks attached to yield farming are the main reason for the creation of Formation Finance. Formation Fi presents is a cross-chain Risk Parity Smart Farming 2.0 solution to yield farmers. By adapting to core principles from All Weather by Bridgwater for the yield farming environment, this Risk Parity protocol offers four classes of cross-chain yield farming strategies to farmers in the form of the following index coins. … Continued
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