Yield farming has become a cornerstone of DeFi, driving innovation in the industry by providing the liquidity needed to drive adoption. With over $13B of value locked in yield farming tokens and over $2B in daily trading volumes, this practice offers significant earning potential for cryptocurrency enthusiasts.
Participants earn rewards through governance tokens or a share of the fees by providing liquidity to decentralized exchanges (DEXs) and other DeFi platforms. Rather than holding cryptocurrencies in their wallets, some are using their cryptos to generate passive income.
As crypto yield farming grows, its role as the most significant driver in DeFi’s rapid expansion solidifies. This article explains yield farming, examines today’s market’s most promising yield farming platforms, and shows you how to start earning through cryptocurrency farming.
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What is crypto yield farming?
Crypto yield farming is a DeFi strategy in which users earn rewards by using their cryptocurrency without selling it. It is considered a high-risk strategy and may not be suitable for all.
Unlike simply holding assets, yield farming involves actively participating in decentralized finance protocols to generate passive income. This approach has become popular among investors looking to maximize the utility of their holdings.
Yield farming primarily involves providing liquidity by depositing crypto into liquidity pools on decentralized exchanges (DEXs) and lending cryptos in borrowing and lending protocols. In return, liquidity providers (LPs) earn rewards, typically from trading fees or native token emissions, while interest is paid on lent cryptocurrencies.
Imagine owning two digital assets, like apples (ETH) and oranges (USDC). You place these into a communal basket called a liquidity pool. The pool (or basket) allows other users to trade apples for oranges or borrow them for a fee. You earn a slice of that fee as someone contributing apples and oranges.
The appeal of yield farming lies in its potential to generate significant returns. For example, in 2023, over $95 billion in crypto assets were locked in DeFi protocols—an astounding jump from $32B just a year prior—with yield farming alone contributing nearly $8 billion in payouts, as DeFi Pulse suggests.
Some protocols offered annual percentage yields (APYs) ranging from 25% to over 100%, making them attractive options for long-term holders.
However, yield farming has risks like price volatility, impermanent loss, and platform vulnerabilities (we’ll discuss these risks below).
How does yield farming work?
As mentioned above, crypto yield farming can earn rewards on your cryptocurrency by providing liquidity, lending, or staking within DeFi protocols.
At its core, it provides liquidity to a liquidity pool, essentially a pool of funds used by decentralized exchanges (DEXes) or finance and lending platforms to facilitate crypto trading or lending activities. In return, you earn interest, rewards, or a share of the transaction fees generated by the pool.
Liquidity providers (LPs)
Liquidity providers (LPs) are the backbone of some of the best DeFi tokens.
By depositing cryptocurrency into liquidity pools, LPs enable trading, lending, or other activities on decentralized exchanges (DEXes) like Uniswap or lending platforms like AAVE. These pools require equal amounts of two tokens (e.g., ETH and USDC), ensuring seamless transactions.
In return, LPs earn rewards such as transaction fees or governance tokens like UNI or COMP, distributed proportionally based on their pool share. Beyond earning rewards, LPs receive LP tokens as proof of their contribution, representing their pool ownership.
These tokens can often be staked on other protocols to generate additional returns, creating multi-layered earning opportunities. LPs benefit from both passive income and the chance to reinvest earnings to capitalize on the compounding effect.
However, LPs can face risks like impermanent loss, where token prices can fluctuate, reducing the value of the deposited cryptocurrencies. Managing liquidity pairs and monitoring risks is essential for maximizing rewards in this complex but rewarding ecosystem.
When you deposit funds into a liquidity pool, you are issued LP tokens, which act as a receipt for your contributions — basically proof of ownership in the liquidity pool. These tokens track your pool share, including the rewards it generates.
They can be redeemed for your initial deposit and any accrued fees or rewards. LP tokens offer flexibility beyond liquidity provisioning—they can be staked in yield farming strategies to unlock additional rewards.
However, their value fluctuates based on pool performance and token prices. This dual functionality as proof of ownership and a tool for further rewards makes LP tokens integral to yield farming strategies, especially for maximizing returns through compounding.
Lenders
Lenders act as the financiers of the ecosystem, providing liquidity to DeFi lending platforms by depositing their cryptocurrencies into lending platforms and earning interest on their deposited assets.
These funds are pooled and made available to borrowers, who pay interest on their borrows. Interest rates depend on market demand and the supply of specific assets, offering lenders a way to earn passive income with relatively low risk, especially when using stablecoins.
Unlike liquidity providers, Lending is a simpler way to engage in crypto farming since you don’t need to manage liquidity pairs or worry about impermanent loss.
Additionally, lenders retain control of their deposits, withdraw their funds, and earn interest at any time. They can also use this method to farm stable yields.
Borrowers
Borrowers in DeFi access funds from liquidity pools by depositing collateral, typically worth more than the amount they intend to borrow. For example, depositing ETH as collateral allows borrowers to access USDC without selling their ETH.
This enables users to maintain exposure to their original assets while utilizing borrowed funds for trading, staking, or other strategies.
Interest rates are dynamic and influenced by the demand and supply of the borrowed asset. Borrowing offers flexibility but comes with risks, including liquidation if the collateral value drops. Borrowers are vital to the DeFi ecosystem, creating opportunities for lenders and LPs to earn rewards.
The yield is often presented in two forms: APR and APY.
How is APR/APY calculated?
APR (Annual Percentage Rate) and APY (Annual Percentage Yield) are two methods of calculating returns in yield farming and the key metrics for measuring returns in DeFi. APR is the simple interest earned annually without considering compounding.
For example, if you deposit $1,000 in a pool with a 10% APR and earn $100 annually. The reward is often given in real-time, hourly, daily, or weekly.
APY, on the other hand, includes the effect of compounding, where rewards are reinvested to generate additional returns. If the same pool compounds daily, the APY might increase to 10.5% or higher, depending on the frequency of reinvestment.
Understanding these metrics is helpful for evaluating the profitability of yield farming strategies. Luckily, APY/APR calculators are free online.
What are the risks of yield farming?
While offering attractive returns, crypto yield farming carries several risks that participants should consider before participating.
We can group these risks according to various factors, but mainly as platform and security risks, market and price risks, regulatory and legal risks, liquidity risks, and economic risks. Below, we’ll break down the main risks associated with yield farming.
Platform and security risks
- Smart contract vulnerabilities: Yield farming relies on smart contracts to execute transactions and manage assets. Errors in the code or unforeseen vulnerabilities can result in exploits, leading to loss of funds. Even platforms with audited contracts have been hacked (e.g., the 2020 Harvest Finance exploit). Smart contract security is an ongoing challenge, even for well-established DeFi platforms.
- Rug pulls: One of the more dangerous risks in yield farming is the possibility of encountering a “rug pull.” In this scenario, a project or platform abruptly disappears, taking all the funds. Rug pulls are particularly prevalent on platforms with anonymous developers and a lack of proper due diligence or third-party audits.
- Oracle manipulation attacks: Oracles are vital for yield farming protocols, supplying external data like asset prices to smart contracts. However, they are vulnerable to hacking, and if the data is manipulated, it can lead to incorrect calculations and financial losses. Poorly designed or insufficiently decentralized oracles are particularly at risk, making them targets for attackers. For example, a hacker successfully drained $112 million in digital assets from Mango Markets, a decentralized finance trading platform on the Solana blockchain.
Operational risks: Technical issues like platform outages, network congestion (e.g., during market volatility on Ethereum), or bugs in operational logic can disrupt user activity.
For instance, delays in transaction processing during high network usage can lead to missed opportunities or unintended financial exposure.
Market (and price) risks
Impermanent loss: When you provide liquidity to a pool, the value of the assets you supply can change. If the price of one asset increases or decreases significantly relative to the other, this creates an impermanent loss situation.
For liquidity provision: When you provide liquidity to a pool, the value of the assets you supply can change. If the price of one asset increases or decreases significantly relative to the other, this creates a situation known as impermanent loss.
For lending: The risks differ when you lend assets to a DeFi protocol. While you earn interest on your assets, the primary risk is the potential for borrower defaults or the solvency of the lending platform itself. Unlike liquidity provision, you don’t face impermanent loss but are exposed to platform risks.
- Market volatility: The crypto market is known for its extreme volatility. Asset prices can swing wildly, leading to significant losses, especially if you need to withdraw your funds during a market downturn.
- Price manipulation: Yield farming platforms, particularly those with smaller or less-liquid pools, can be susceptible to price manipulation. Malicious actors might execute trades that artificially inflate or deflate the price of assets in a pool, impacting returns. However, reputable platforms often implement safeguards such as time-weighted averages oracles to mitigate this.
- Flash loan attacks: Flash loans are a form of uncollateralized borrowing that can be used for market manipulation. Hackers can exploit flash loans to execute complex attacks on liquidity pools, draining funds and leaving farmers with nothing.
- Front-running attacks: Bots often front-run trades, meaning they can see an incoming transaction and execute theirs first to profit from the price discrepancy. This can lead to slippage and lower returns for yield farmers, especially in markets with low liquidity.
Liquidity and counterparty risks
- Liquidity concentration risk: If a single entity controls a large portion of liquidity in a given pool, that entity could manipulate the market. This risk can lead to price instability and the potential for market manipulation, affecting the performance of your yield farming investment.
- Counterparty risk: When lending or borrowing assets through yield farming platforms, there’s a risk that the counterparty might default on their obligations. This could lead to losses, especially in platforms without collateral or guarantees.
Strategic and economic risks
Capital re-allocation risk: This is indeed a valid risk in the DeFi space. Changes in reward structures, token emissions, or platform tokenomics can reduce the yield for liquidity providers or stakers. For example:
- Protocol upgrades: DeFi platforms often undergo updates, which may involve reallocating incentives or reprioritizing certain liquidity pools.
- Liquidity migration: When a protocol reduces rewards, capital may flow to more lucrative platforms, potentially diminishing the liquidity and stability of the original protocol.
- Market sentiment: Investors shifting capital to newer or trendier projects could exacerbate risks such as impermanent loss or lower overall returns.
Sybil attacks
This is also a recognized risk, particularly for governance-focused DeFi platforms:
- Mechanism: Malicious actors create multiple fake accounts or control numerous wallets to gain disproportionate influence in governance votes. This undermines decentralized governance principles.
- Outcome: Sybil attacks can result in decisions favoring the attacker, such as adjusting tokenomics, allocating rewards, or even approving fraudulent proposals.
- Mitigation: Some protocols use measures like quadratic voting or reputation-based systems to mitigate this risk, but these solutions are not foolproof.
Other risks to consider include regulatory and compliance issues, as yield farming operates in a gray area in many regions, and changes in government regulations could affect the legality of participation or fund withdrawals.
Additionally, psychological risks come into play, as the high-risk, high-reward nature of yield farming can lead to emotional decisions, such as FOMO or panic selling, increasing the chances of significant losses.
Yield farming vs. staking
DeFi yield farming refers to earning rewards by supplying crypto to decentralized finance platforms. You could do this by adding your assets to liquidity pools on DEXs or lending them to protocols for interest. Both methods offer rewards but come with distinct risks.
Staking is like being a landlord. You lock up your coins to help secure a blockchain network. In exchange, you earn more coins as a reward. Some of the best staking coins are listed here. Here are more differences you might not have been aware of:
| Feature | Yield Farming | Staking |
| Core concept | Actively providing liquidity to DeFi protocols to earn rewards. | Passively holding cryptocurrencies to support network security and earn rewards. |
| Risk profile | Higher risk due to market volatility, impermanent loss, and smart contract exploits. | Prone to slashing, inflation, or asset devaluation risks. |
| Reward potential | Potentially higher returns, especially in bull markets. | Lower returns but more stable returns. |
| Technical complexity | Can be complex, requiring an understanding of DeFi protocols, smart contracts, and liquidity dynamics. | Generally more straightforward, involving basic wallet interactions, may vary for validator roles. |
| Key considerations | Impermanent loss, smart contract exploits, and market volatility. | In some platforms, a higher return is given only if the tokens are locked for a long period of time. |
| Ideal scenario | Bull market with high demand for liquidity and incentivized pools. | Some projects offer a higher yield in an early stage of the project, which may decrease over time. |
Best platforms for yield farming
Yield farming, a popular decentralized finance (DeFi) strategy, allows users to lend their crypto assets to earn rewards. Here’s a brief guide on the best yield farming platforms to get you started.
Yield farming on decentralized exchanges
Decentralized exchanges (DEXs) are used to swap and trade cryptocurrencies. A crypto wallet is required.
Unsiwap DEX
A decentralized trading protocol on the Ethereum blockchain valued at $5 billion aims to automate token trading while remaining completely open to all token holders, improving trading efficiency compared to traditional exchanges. In addition to yield farming rewards, its purpose is to create liquidity.
Pancakeswap DEX
Decentralized finance protocol that allows for the exchange of cryptocurrencies using blockchain technology, specifically through an automated market maker (AMM) model for BEP-20 tokens. The recent PancakeSwap V3 introduces innovations to enhance capital efficiency, reduce trading fees, and increase earnings for liquidity providers.
Raydium DEX
Decentralized exchange built on the Solana blockchain boasts over $2 billion in total value locked (TVL).
It offers high-speed transactions and unique yield farming opportunities in everything from Solana meme coins to utility tokens, making it an appealing platform for yield farmers.
Raydium operates using an automated market maker (AMM) model, allowing users to swap and trade tokens and become liquidity providers.
YieldFlow
A DeFi platform focusing on yield farming strategies, providing tools and insights to optimize returns. YieldFlow simplifies the process of yield farming by automating strategies and offering better-than-industry-average APYs averaging 20% – 25%, though returns may vary with market conditions.
Yield farming on centralized exchanges (CEXs)
- MEXC: This MEXC review outlines that this centralized exchange offers a unique staking product called MX-DeFi. This yield farming solution allows users to stake their MX tokens or tokens from other projects to earn high yields. The staked tokens are utilized in various DeFi protocols, and the returns generated are distributed to the stakers.
- OKX: Diverse range of yield farming opportunities with competitive APRs. With OKX Earn, you can earn interest on your assets through various investment options. The products available include Simple Earn, Loan, and On-chain Earn. You’ll discover multiple yield farming pools featuring different assets and reward structures.
- Bybit: Earn up to 100% APR on crypto by adding liquidity to pools with Bybit. You can leverage your investment for higher yields or remove your liquidity anytime, as seen in this Bybit review. Furthermore, Bybit’s liquidity mining pool offers potential 100% returns and enhance yields with up to 3x leverage. Their Flexible Savings program offers guaranteed yields for staked tokens locked for a specified period.
Borrowing and lending yield farming protocols
These are some of the top lending and borrowing protocols you can use today to earn a passive yield on your cryptocurrencies.
Compound protocol
On the surface, the decentralized lending protocol works as an algorithmic, autonomous interest rate protocol with over $2B TVL that allows users to lend and borrow crypto assets and earn interest on their deposits. You can earn interest in COMP tokens by lending your crypto assets on Compound.
Aave protocol
Well-known DeFi lending protocol with an impressive total value locked (TVL) of $17 billion as of the publication date. It provides various lending and borrowing options, including flash loans. Users can lend their cryptocurrency assets and earn interest in the form of AAVE tokens.
Alchemix protocol
A DeFi protocol that enables the creation of synthetic tokens representing a deposit’s future yield. It allows users to obtain near-instant tokenized value against temporary deposits of stablecoins. Alchemix offers a unique approach to yield farming by enabling users to leverage their staked assets to earn additional rewards.
What to expect from yield farming in 2024 and 2025
Yield farming remains a valuable strategy in cryptocurrency markets, but it requires careful planning and an understanding of evolving trends.
With L2 chains like Base, Optimism, and Arbitrum offering high APYs at launch, early adoption often leads to significant rewards. Following liquidity is key—chains with large development grants usually attract developers and projects, creating profitable opportunities in DEXs, lending platforms, and Layer 1 tokens.
For those exploring DeFi, “liquid restaking” through protocols like EigenLayer offers compelling opportunities, particularly for ETH holders.
FAQs
How much money do you need for yield farming?
Is yield farming safe?
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Is a DEX safer than a centralized platform?
Do I need to lock tokens in yield farming?
References
Crypto Funds Are Hunting for Yield | The Information
DeFi Market Rebounds to $50B as Speculators Hunt for Yield | CoinDesk
MEXC Launches “MX DeFi” Yield Farming to Remain the top Centralized DeFi Token Supporter | MEXC Blog
Decentralized Finance (DeFi): opportunities, challenges and policy implications | Study by Eurofi
