A Brief Breakdown on Yield Farming
What is Yield Farming?
In a nutshell, yield farming allows crypto holders to create passive income by providing their liquidity, or crypto, to platforms to earn interest. The process is achieved with the use of smart contracts, that perform actions such as release funds or profits once certain conditions are met without requiring human interaction. This is revolutionary as it removes the need to trust the other party to hold their end of the deal. Ethereum and ERC-20 tokens were the first to do this with the development of smart contracts in 2018.
Yield farming is no longer limited to the Ethereum network, as CoinFLEX has revolutionised the game by creating the ability to develop smart contracts on the Bitcoin Cash network, called smartBCH. smartBCH is the future of smart contracts as it is truly decentralized being secured by the same network as Bitcoin and Bitcoin Cash, compared to say Solana or Binance Smart Chain (BSC), which are largely centralised. smartBCH has multi thread processing instead of Ethereum’s single thread, making it far faster and cheaper with gas fees being US cents or fractions of a cent compared to Ethereum fees in the hundreds or thousands US dollars.
smartBCH is also Ethereum Virtual Machine (EVM) compatible, using SEP20 tokens, which are the equivalent of ERC20. This means all applications and contracts written on Ethereum can work on smartBCH in order to preserve the wealth of code running decentralised apps on Ethereum.
What is Staking?
Staking is when you lock up funds into a smart contract for a period of time and by doing so you get rewarded with a percentage of that staked token. Staking is not only beneficial to the person locking away their crypto, but also to the ecosystem, as it reduces its market supply. This not only limits the supply and thereby increasing the demand, but also lets the market know a specific amount of the crypto cannot immediately be sold off, as many are locked away for varying vesting periods.
Staking offers high annual percentage yield, or APY. APY is the amount of money you will earn from your rate of return over a one year period with compound interest. If you were to do a quick google search right now, you can see the average savings account interest rate earns you a measly 0.01%-0.05%. To make matters worse, as our central banks endlessly print money, year by year the value of your fiat decreases. Crypto’s APY are often in single or double digits, which is orders of magnitude higher than our outdated and flawed traditional financial system. These are the types of revolutionary benefits crypto, and DeFi specifically, are offering to the world.
What are Liquidity Pools?
Liquidity pools are another great way for DEXes to provide the capital for users to trade. CEXes, or centralised exchanges, have investors with enormous capital who provide the liquidity necessary for their exchange to operate. CEXes are known as the “market makers” because as the name suggests they provide the money, or liquidity, for the market to exist.
As DEXes, or decentralised exchanges, have no centralised or concentrated investors that provide the capital necessary to make the market. They use what’s called Automated Market Making, or AMMs to generate the capital needed to facilitate trades.
This is done through the use of liquidity pools, where small amounts of capital, or liquidity, is provided by many individuals known as liquidity providers, or LPs. The retail traders now become the makers of the market to allow other retail or institutional traders to become the takers by using the capital to trade. Just like with CEXes, these liquidity providers are rewarded with trading fees. The amount they earn from trading fees is proportional to how much they invested into the pool.
At CoinFLEX, the rewards don’t end there, LPs can also concentrate their liquidity and earn fees with AMM+ in certain price ranges to maximise profits. You can further capitalise on these gains by leveraging your position. In addition to this, LPs are provided with LP tokens, which represent the amount of crypto they have staked in the pool, and can earn extra yield by staking this token once more!
We can see that liquidity pools can be extremely lucrative at CoinFLEX, by providing several additional ways to earn capital with just one investment . One major drawdown to the liquidity pool is from impermanent loss, which results in the value of your crypto decreasing, as the ratio of your staked coins changes from price fluctuation. If you don’t want to expose yourself to that much risk, the safest way to do so would be to simply lend.
How Does Lending and Borrowing Work?
Another way yield farmers can generate wealth is through lending and borrowing. One simple way of increasing your APY is through supplying stablecoins.
At CoinFLEX, you can begin to immediately earn interest just by holding its stablecoin flexUSD! flexUSD is the first multi-yield bearing stablecoin and the first stablecoin that pays interest at the base level, meaning that it will generate additional capital simply by holding the coin. This is a phenomenal way to let your additional capital work for you compared to holding it in other coins such as USDC. You can then use your interest bearing stablecoin off the platform onto DeFi lending platforms to yield farm your assets further.
To paint an accurate picture of what you can experience from yield farming it’s necessary to talk about the risks. As yield farming is a product of smart contracts, it’s important to understand you are at the mercy of the quality of the code within the smart contract. If they have any issues, failures, flaws within the code, or hacks, then you could have your crypto stolen.
Ensure you use safe protocols to yield farm, such as at CoinFLEX, which combines the safety of a CEX, while decentralising the custody and clearing, meaning you have complete control over withdrawing your assets. Whilst this is not live yet, soon CoinFLEX will be transitioning from being the sole private key holder for your assets to only being one of many, in a multi-sig signature process. A multi-sig signature process requires a set number of signatures to control assets in a wallet. As CoinFLEX does not have access to your signature, they cannot have control of your funds. It is imperative you keep your signature a secret to anyone, including employees at CoinFLEX.
Yield farming offers enormous opportunities for passive capital to increase their wealth more than just simply holding their crypto. It’s understandable why yield farming is so lucrative considering the importance these LPs have in facilitating trades at DEXes or AMMs. Yield farmers have the opportunity to earn multiple streams of income if using the right approach, however the more exposed to the market you are the higher your risk becomes. Remember, before investing or putting your hard earned crypto at risk please ensure you do your own research before making any investments.
Author: Adam Diaz
Disclaimer: This is not financial advice and is for educational purposes only. Please do your own research or speak to a financial adviser before investing.