Growing your cryptomoney… but not without risks – What is yield farming?

The DeFi ecosystem is constantly being talked about. In the space of a few months, the funds involved in the protocols that make it up have been multiplied by ten. With this craze, a new phenomenon has appeared: yield farming. Let’s take a look back at this practice which is setting DeFi on fire.

History of yield farming

Before we understand the phenomenon of yield farming, let’s take a look at the emergence of this term.

At the end of 2019, more and more protocols hosted on Ethereum will begin to be talked about. Uniswap, Compound or Aave, their names are probably not unknown to you.

These protocols have come to the forefront with an interesting value proposition: offering users classic financial services in a decentralised manner.

Thus, all of these protocols offer benefits to their users who have deposited cryptomoney in the protocol’s liquidity pools.

Until now, the mechanisms were relatively basic: you deposited cryptomoney on the protocols and were rewarded with fees, whether they were generated by exchanges in the case of Uniswap or generated by loans taken out by other users of the protocol.

However, everything changed with the arrival of the Uniswap pool subsidised by Synthetix. Thus, Synthetix wished to find a way to encourage users to provide liquidity when they exit the sETH/ETH pool on Uniswap. To do so, Synthetix began rewarding the first participants with SNX tokens. As a result, the suppliers in the pool generated two types of rewards:

Rewards from the exchange fees generated by the pool,
SNX rewards from Synthetix incentives.

This is how the term yield farming came to be coined. It was not democratised with the proliferation of governance tokens throughout the DeFi ecosystem.

Subsequently, centralised exchange platforms began to propose yield farming strategies, for fear of being overtaken by the craze for decentralised protocols.

So what is yield farming?

As we have seen, yield farming refers to strategies aimed at optimising the yields generated by the cryptomoney deposited on the various DeFi protocols.

For a long time limited to deposits on a single platform, yield farming strategies have since evolved to take advantage of the interweaving of the various DeFi protocols with the aim of adding up the rewards.

Opportunities and warnings

As with the ICO movement in 2017, the yield farming phenomenon includes as many good opportunities… as it does bad ones. For example, CoinGecko proposes a ranking of pools for yield farming. In this ranking, we find all types of returns ranging from a few percent per year to several thousand (!) depending on the strategy.

Several factors are therefore important to take into account.

First of all, it is important to look at the platform that proposes the strategy. Indeed, every day new DeFi platforms are being created, however not all of them are reputable. Some are even extremely risky to use because they are not audited.

Secondly, it is necessary to look at the assets involved in the pool. Once again, with these platforms often come governance tokens, most of them also unaudited.

In the end, to minimise the risks, we prefer audited and recognised platforms and cryptomoney. Of course, minimising risk leads de facto to minimising returns.

Yield farming strategies for all exchanges

You are probably aware that Ethereum is currently going through a phase of intense congestion. As a result, transaction costs have reached record levels on the network.

Due to these abnormally high fees, it is essential to adjust its yield farming strategies to ensure that our returns are not squandered on transaction costs.

To do this we will explore two totally different strategies.

Binance Liquidity Swap

The first solution is mainly aimed at users wishing to invest small amounts. The objective here will be to test yield farming, while ensuring that the returns are not entirely lost in transaction costs.

To do this, we will turn to centralised yield farming strategies, such as the one proposed by Binance with Binance Liquidity Swap.

With this new product, Binance is introducing a centralised version of a liquidity pool-based trading platform, based on the same model as the DEXs of decentralised finance.

At the time of writing, Liquidity Swap has 4 pools BUSD/USDT, USDT/DAI, BUSD/DAI and USDC/USDT which offer annualised returns between 5 and 20%.

Why is this strategy recommended for small exchanges like Bitcoin Cycle? Because it allows you to take part in yield farming without going through Ethereum. As a result, it allows you to take positions and recover your profits without paying the huge transaction fees charged by Ethereum.

Obviously, as this strategy goes against the adage „Not your keys, not your corners“, it is not recommended for people with large portfolios, or who are uncompromising about decentralisation.

Yearn and the yVaults

For this second yield farming strategy, we are going to turn to the Yearn decentralised protocol. As we will be using Yearn, this implies that we will have to pay Ethereum’s transaction costs and therefore this strategy will be better suited to medium to large portfolios.

Thus, Yearn offers several products called yVault. Each of these „vaults“ or safes is a programme that automatically optimises yield farming strategies on a given asset. Yearn offers a total of 9 yVaults:

  • YFI
  • crvBUSD
  • crvBTC
  • DAI
  • TUSD
  • USDC
  • USDT

These nine safes offer annualised returns ranging from 0.05 to 13.28%, at the time of writing.

In practice, the vaults will use the assets they contain by depositing them in the protocol(s) with the best returns. To calculate the best return, the yVaults take into account the interest generated by the protocols, incentive rewards and governance tokens earned through liquidity mining.

For example, when using the DAI vault it can: deposit the DAIs on Compound which will result in the generation of cDAIs. Then deposit the freshly generated cDAIs on Balancer. In the end, this allows you to earn COMP tokens on the DAI deposited on Compound and BAL tokens on the cDAIs deposited on Balancer, in addition to the interest provided by Compound and the transaction fees collected from the Balancer pool. A real cascade of investment, as some could already try with the Furucombo tool!

Some additional strategies

We will now detail a few more strategies to help you find the one that best suits your portfolio and your ideals. We will propose both centralised and decentralised strategies.

Centralised strategies :

  • Centralised loan and savings platforms such as BlockFi or Celcius. They will allow you to generate your first interest on your cryptos, without worrying about transaction costs.
  • Centralised liquidity pool trading platforms such as Binance Liquidity Swap. This allows you to generate interest via the transaction fees collected by the platform.

Decentralised strategies:

  • Centralised loan and savings platforms such as Compound or Aave. These allow interest to be generated on ERC-20s in a decentralised manner.
  • Decentralised exchange platforms such as Uniswap or Balancer. They allow interest to be generated thanks to the exchange fees recovered at the time of each swap.
  • Couple the previous strategies by adding rewards from liquidity mining. In this case, it is equivalent to depositing cash in pools benefiting from the liquidity mining process on Compoud, Uniswap or Balancer in order to generate governance tokens, in addition to the rewards mentioned above.
  • Use the Yearn yVaults that automatically compose between all the decentralised strategies presented above.

As we have just seen, there are a multitude of strategies to take part in yield farming, whatever the thickness of your portfolio. Nevertheless, it is important to remain vigilant before taking part in these strategies at the risk of making irreversible mistakes.