Yield Farming Is Making Banks Uneasy

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Yield Farming Is Making Banks Uneasy
<a href="https://pixabay.com/users/cegoh/">cegoh</a> / Pixabay

DeFi has a bright future ahead.  It offers a viable alternative to traditional investments, particularly as central banks cut interest rates and, in some examples, offer negative interest  rates so that account holders pay banks for the privilege of  holding your money. The DeFi space introduced to a far wider audience the concept of  yield through which your funds work for you. It is direct competition for the bank, and that’s why they’re scared.

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Whether or not the current  breed of projects drive DeFi forward or we see a new resilient crop sprout in the future as we figure the technology out, the space has a promising future. There is far too much money being put at stake for the industry to simply disappear just like that. People are clearly willing to take exorbitant risks on new types of finance, and those sophisticated users are being handsomely rewarded.

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For now, DeFi is still relatively new. And, although you could argue that Bitcoin and Ethereum  are DeFi by their very nature, the novel breed of yield farming products is making the banking industry quite uneasy--and rightfully so. As enterprises adopt blockchain for their supply chains or treasuries, big banks have yet to do so, for it is a direct threat on how they operate and DeFi is only just getting started. Here’s how yield farming poses a threat to big banks.

What Is Yield Farming?

First, let’s discuss what yield farming is in the first place. Yield farming allows cryptocurrency holders to lock up their holdings, which in turn provides them with rewards. It is a process empowering users to earn either fixed or variable interest by investing crypto in a DeFi market.

Yield farming most often involves lending cryptocurrency via the Ethereum network. Loans are made via banks using fiat money, and that amount is then paid back with interest. Yield farming allows funds to be lent out via DeFi protocols.

Yield farming is using ERC-20 tokens on Ethereum. Rewards are in the form of ERC-20 token. Nearly all current yield farming transactions take place in the Ethereum ecosystem.

The first step in yield farming entails the adding of funds to a liquidity pool, which are essentially smart contracts that contain funds. The pools enable a marketplace where users exchange, borrow, or lend tokens. Once tokens have been added to a pool, you’ve official become a liquidity provider.

This entails locking money in a project for interest in return. It entails a lot of risk, such as theft. The money you put up as yield is held by software, and many DeFi projects have been hacked over the years.

Early investors often hold large shares of reward tokens, and their moves to sell could impact token prices. Regulators furthermore have yet to opine on whether reward tokens could be securities, which could have a big impact on the coins’ use and value. Many high-yield harvesting strategies hold the risk of liquidation. Many users must adapt quick thinking and complex strategies, such as depositing DAI tokens into Compound, then borrowing DAI using initial tokens as collateral, then lending out the borrowed funds.

While the idea is to accumulate more allocated rewards of Comp tokens, if the price declines, all gains could be wiped out and liquidation could be triggered.

Earning interest by lending cryptocurrency has been possible heretofore with apps such as BlockFi, as part of a trend of decentralized finance, in which middlemen like banks are replaced with automated protocols or dapps.

A main difference between BlockFi and Compound, however, is the latter offers implied rights to cash flows. Users are incentivized to participate in governing and improving the networks. Small traders could be eaten alive by the whales who capture most rewards.

Even if banks aren’t afraid of the increasingly sophisticated products produced by blockchain and cryptocurrency technology, they must be at least paying attention. DeFi represents a complex array of platforms which allow borrowers, lenders, and investors to take part in financial activities without banks.

Anyone with an internet connection can take part in the DeFi ecosystem, including yield farming. They can store and transfer value, and access any financial product imaginable sans banks, brokers, and politicians. All one needs is a digital wallet you can download for free from a website.

So maybe the billion or so dollars presently locked into DeFi apps doesn’t match the trillions locked in traditional finance, but the excitement surrounding the rapidly growing DeFi ecosystem is palpable. In a low interest rate environment, big institutions are putting Bitcoin in their treasuries. Next, they might just start considering what DeFi and things like yield farming.

Yield farming is but one product made possible by DeFi, and is but one offered by non-banks. Traditional banks and investment houses risk being left behind. This new asset class has potential of high returns. They might consider taking the Jamie Dimon approach, who criticized Bitcoin only to watch his bank experiment with its own stablecoin, JPMorgan coin.


About CryptoShark

With a background in IT spanning Software Engineering, Business Analysis and Intelligence and Infrastructure Architecture, CryptoShark first found the Cryptocurrency space through mining Ethereum from a spare gaming computer and later developed the popular decentralized charting platform, ChartEx.

Working in the FinTech industry, it wasn’t long before he started applying his analytical skills, coupled with a software engineering background to build tools to analyse trading data from emerging exchanges. This led CryptoShark to build ChartEx, a leading provider of full candlestick charting and other widely used trading tools for markets in the largest exchanges in the industry.

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