Yield Farming Basics
What is Yield Farming
Yield farming is providing assets to DeFi protocols and receiving rewards. Like the "farming" metaphor, you "plant" assets to "harvest" yields.
Core concept:
- Asset deposit: Provide tokens to protocol
- Protocol utilization: Used for liquidity, collateral, lending, etc.
- Reward receipt: Fees, incentive tokens, etc.
It exploded in 2020's "DeFi Summer" with Compound's COMP token distribution.
Sources of Yield Farming Revenue
1. Transaction Fees
A portion of fees paid by users goes back to liquidity providers.
DEX Example:
- Uniswap: 0.3% swap fee → Distributed to LPs
- Curve: 0.04% swap fee → To LPs
Sustainability: High (generated from actual usage)
2. Interest Income
Depositing in lending protocols earns interest paid by borrowers.
Example:
- Deposit USDC in Aave → Receive portion of borrower interest
- Deposit ETH in Compound → Receive borrower interest
Sustainability: High (generated from actual demand)
3. Incentive Tokens (Liquidity Mining)
Protocols distribute their own governance tokens as additional rewards.
Example:
- Curve LP → CRV token rewards
- Convex → CVX token additional rewards
- New protocols → High APY as initial incentive
Sustainability: Low (depends on token issuance, inflationary)
4. Protocol Revenue Distribution
Some protocols distribute revenue to token holders.
Example:
- GMX: 70% of fees distributed to stakers in ETH
- dYdX: Portion of fees to stakers
Sustainability: High (actual revenue distribution)
Main Types of Yield Farming
1. Liquidity Provision (LP Farming)
Provide liquidity to DEXs and receive rewards.
Process:
- Prepare token pair (e.g., ETH + USDC)
- Supply liquidity to DEX → Receive LP token
- Hold LP token → Earn fee income
Additional Incentives:
- Stake LP token in protocol → Additional token rewards
- Example: Curve LP → Stake in Convex → CRV + CVX rewards
2. Lending Farming
Deposit in lending protocols for interest + incentives.
Process:
- Deposit tokens in Aave/Compound
- Interest income (borrower interest)
- Incentive token rewards (if available)
3. Staking Farming
Stake protocol governance tokens for rewards.
Example:
- CRV staking → veCRV → Protocol fees + boost
- GMX staking → ETH/AVAX revenue distribution
4. Leveraged Farming
Use leverage to amplify yields.
Process:
- Deposit collateral
- Borrow
- Additional farming with borrowed funds
- Repeat
Yield: APY x Leverage - Borrowing Interest Risk: Increased liquidation risk
Understanding APY
APY Composition
| Component | Example | Sustainability |
|---|---|---|
| Base fees | 5% | High |
| Incentive tokens | 50% | Low |
| Boost rewards | 20% | Medium |
| Total APY | 75% |
APY Considerations
1. Incentive Token Price:
- APY is based on current token price
- Actual yield decreases if token price drops
2. Dilution Effect:
- TVL increases → APY decreases
- Capital flows to high APY → Yield diluted
3. Compounding Assumption:
- Displayed APY assumes auto-compounding
- Consider gas fees for manual compounding
4. Impermanent Loss:
- Impermanent loss not reflected in LP farming
Popular Yield Farming Protocols
Curve Finance
Features:
- Stablecoin-specialized DEX
- Low slippage, low fees
- CRV token incentives
Yield Structure:
- Base LP fees: ~0.5~2%
- CRV rewards: Variable
- Boost: Up to 2.5x based on veCRV holdings
Convex Finance
Features:
- Built on top of Curve
- Optimizes CRV yield
- CVX additional rewards
Yield Structure:
- Curve base yield
- CRV rewards (boost applied)
- CVX rewards
Aave/Compound
Features:
- Lending protocols
- Simple deposit for interest
- Stable but low APY
Yield Structure:
- Deposit interest: 1~10% (varies by asset/market)
- Incentives: Additional if available
GMX
Features:
- Decentralized perpetual futures exchange
- Real yield distribution (ETH, AVAX)
- High real yield
Yield Structure:
- 70% of platform fees: To GMX stakers
- esGMX: Additional incentive
Yearn Finance
Features:
- Yield aggregator
- Auto strategy optimization
- Gas fee savings
Yield Structure:
- Underlying protocol yields
- Yearn fee deduction (20% of performance)
Yield Farming Strategies
1. Stablecoin Farming
Strategy: Farm in stablecoin pools with lower risk
Example:
- Curve 3pool (USDC/USDT/DAI)
- Aave USDC deposit
Advantages:
- Low price volatility risk
- Almost no impermanent loss
Disadvantages:
- Relatively low APY
- Depegging risk
2. Correlated Asset Farming
Strategy: Asset pairs that move similarly in price
Example:
- stETH/ETH (Curve)
- WBTC/renBTC
Advantages:
- Minimizes impermanent loss
- Maintains exposure to both assets
Disadvantages:
- Loss if one side depegs
3. Single Asset Farming
Strategy: Deposit single tokens without pair composition
Example:
- Deposit ETH in Aave
- GLP on GMX (works like single deposit)
Advantages:
- No impermanent loss
- Simple
Disadvantages:
- Usually lower APY
4. Incentive Chasing
Strategy: Move to follow high incentives
Example:
- Early high APY on new protocol launches
- Limited-time boost campaigns
Advantages:
- Short-term high yield possible
Disadvantages:
- Gas fee accumulation
- New protocol risks
- Unsustainable
Yield Farming Risks
1. Smart Contract Risk
Fund loss due to protocol bugs or hacks.
Mitigation:
- Use verified protocols
- Check audits
- Get insurance (Nexus Mutual, etc.)
2. Impermanent Loss
Loss due to asset ratio changes when providing LP.
Mitigation:
- Choose correlated asset pairs
- Use stablecoin pools
- Calculate IL before entering
3. Token Price Decline
Actual yield decreases when incentive token price falls.
Mitigation:
- Regularly harvest and sell
- Evaluate token value
- Avoid excessive dependence
4. Liquidation Risk (Leveraged Farming)
Liquidation risk when using leverage.
Mitigation:
- Conservative leverage
- Monitor health factor
- Have stop-loss plan
5. Rug Pull
Malicious developers steal funds.
Mitigation:
- Be cautious of anonymous teams
- Check track record
- Be wary of new protocols with low TVL
Getting Started with Yield Farming
Preparation
- Wallet: MetaMask or other Web3 wallet
- Assets: Tokens to farm
- Gas fees: Native tokens (ETH, etc.)
- Research: Understand the protocol
Basic Process (Curve Example)
- Select pool: 3pool, stETH, etc.
- Prepare tokens: Acquire relevant pool tokens
- Add liquidity: Deposit on Curve
- Receive LP token: Proof of deposit
- Stake (optional): Stake on Convex, etc.
- Harvest rewards: Periodically Claim
- Compound or withdraw: Process harvest
Checklist
- Verify protocol audit status
- Check TVL and track record
- Understand APY components
- Assess risks (IL, smart contract, etc.)
- Check entry/exit fees
- Consider gas fees
Tax Considerations
Yield farming rewards are taxable in many countries.
Possible Tax Events:
- When receiving reward tokens
- When swapping tokens
- When withdrawing and selling
Record Keeping:
- All transaction records
- Price at time of receipt
- Professional consultation recommended
Summary
Yield farming is depositing assets in DeFi protocols to receive rewards like fees, interest, and incentive tokens. There are various methods including liquidity provision, lending, and staking, with popular protocols like Curve, Convex, Aave, and GMX. High APY often depends on incentive tokens and may not be sustainable. Understand risks like smart contract risk, impermanent loss, and token price decline, and start carefully with verified protocols.
Next article: Real Yield vs Inflation - Where's the Real Profit?