One of the possibilities offered by decentralized finance is farming. Many companies have been built around this concept and thousands of…
One of the possibilities offered by decentralized finance is farming. Many companies have been built around this concept and thousands of investors have entered the DeFi ecosystem attracted by the benefits of farming.
In this article we will see what farming is and what it allows us to do.
Farming consists of earning returns on cryptoassets by depositing them in protocols of the DeFi ecosystem. The return that investors receive comes not so much from fluctuations in the price of the assets, but from the rewards granted by the protocols for depositing the assets.
Types of farming
Farming encompasses various ways of earning returns on digital assets.
Staking: In staking, users block a number of tokens to help validate a blockchain in exchange for interest. That token is usually the network’s native cryptocurrency.
Staking can also be done on a protocol. In this case, it consists of blockchain governance tokens on the platform in order to obtain voting power and/or a certain return depending on the protocol.
Lending: In lending, we lend our tokens to another person in exchange for interest. Importantly, although it is not risk-free, it usually works with the obligation to provide collateral from the borrower, which reduces credit risk.
Yield Farming: Consists of users depositing a pair of tokens into a liquidity pool, which facilitates exchanges of those tokens in exchange for interest.
It is the most common form of farming, with numerous protocols offering liquidity pools. However, it has a special risk called Impermanent Loss (IL) that users must be aware of and is not present in sataking or lending.
Other Forms of Farming: In addition to these forms of farming, there are others such as liquid staking, yield aggregators and more complex strategies such as delta-neutral trading, leveraged liquidity and lend-borrow.
Common Risks
All of these farming methods share certain risks, such as the risk of scams or hacks, as well as market risk due to the volatility of token prices.
Therefore, it is essential to investigate the protocol in which funds are deposited and to consider diversification not only between different tokens, but also between different protocols.
Rewards
Rewards are usually given in the form of the assets deposited so that, over time, the balance held by the investor of that asset is greater. For example, if an investor deposits 10 ETH in AAVE, he will have more ETH when he goes to withdraw it.
However, there are protocols that reward investors with tokens other than those deposited in addition to the normal return. These additional tokens are usually protocol governance tokens.
Farming DeFi vs farming CEX
It is possible to implement a farming strategy in both decentralized exchanges and centralized exchanges, although each approach has its own considerations.
First of all, it is important to note that in both farming methods, we are entrusting the custody of our funds to a third party, which carries certain risks, such as the possibility of hacks, attacks or company insolvency in the case of centralized platforms.
However, the main and most critical difference is profitability. In general, profitability tends to be higher when using a DeFi protocol compared to a centralized platform. For example, on Binance, at the time of this writing, the return on the OP/USDT pair is 0.92%, while on Velodrome, a prominent protocol on the Optimism network, the return is 15.43%.
This disparity in returns is considerable and deserves special attention.
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