Yield farming is a process that allows cryptocurrency holders to earn rewards on their holdings. With yield farming, an investor deposits units of a cryptocurrency into a lending protocol to earn interest from trading fees. Some users are also rewarded with additional yields from the protocol’s governance token.
Estimated yield returns are calculated on an annualized model. This shows the possible earnings for locking up your cryptos for a year. Some most common metrics include annual percentage yield (APY) and annual percentage rate (APR). The primary difference between them is that APR does not consider compound interest, which involves plowing back one’s profits to increase the returns.
Still, most calculation models are simply estimates. It is not easy to accurately calculate returns on yield farming because it is a dynamic market. A yield farming strategy could deliver high returns for a while, but farmers could always adopt it on a mass scale, leading to a drop in profitability.
Yield farming requires liquidity providers to supply funds into pools to earn yields and trading fees from decentralized exchanges (DEXs). This offers liquidity providers market-neutral returns, but it could be risky during sharp market moves.
« Back to Glossary Index