The total value locked in decentralized finance protocols grew from a mere $690.9M in January 2020 to $78.7B in March 2021. Behind this exponential growth of DeFi is a reward system that has attracted people from all around the world. That reward system is called yield farming.
Thousands of investors both experienced and inexperienced rushed to generate profits since yield farming gained popularity. Some made sizable fortunes and some lost their capital. But, irrespective of the outcome, yield farming attracts plenty of investors even today. So, what exactly is yield farming, and is there a way to optimize it?
Yield Farming in DeFi and the Risks Involved
Yield farming in DeFi, in the simplest terms, is the process of depositing crypto assets into a DeFi protocol to earn rewards. It is just like depositing money in a bank. The returns of yield farming, however, are much greater than those of a bank. There are a set of users called liquidity providers (LP) who lock up their crypto assets into liquidity pools and earn either a fixed or a variable rate of interest as a reward.
Liquidity providers can increase their profits further by re-investing these rewards into other DeFi protocols. The returns on yield farming this way could be huge. In fact, top yield farmers earn up to 100% APR (Annual Percentage Rate) by applying some sophisticated strategies. But, the keyword here is “sophisticated.” What we have to keep in mind is that the crypto space is extremely volatile