Farming is a combination of ways or tools which helps earn rewards in the DeFi world. It is like mining but without an actual miner :)
DeFi Farming contains several strategies like liquidity mining, staking, lending, and borrowing…. But the central part of Farming is liquidity mining. You can think about the meaning and check the semantics of liquidity mining. It means mine some reward by using your liquidity.
Farming and liquidity mining refers to providing liquidity in a DeFi protocol for a reward. These rewards can be fees, interest, or tokens issued by the DeFi protocol. This can involve holding a specific asset or token in DeFi protocols or two tokens in a liquidity pool, which allows other users to trade the asset on the protocol's exchange.
You can learn more about liquidity pools in our article.
By providing liquidity, farmers can earn a portion of the fees generated by the protocol and a share of the protocol's Governance token. Let’s check the PancakeSwap Farming on BSC. You can see a nice opportunity to invest CAKE & WBNB in the liquidity pool and participate in farming with 19% APY.
Here are some stats about this Farming opportunity on PancakeSwap from Defilama.
Pool CAKE-WBNB on PancakeSwap has a grate yield of 19.1% APY. But you should take into account that you receive two types of rewards.
First - Base, this is an actual fee from traders who exchange CAKE to WBNB through this pool.
Second - Reward, this is a liquidity mining reward in CAKE tokens. PancakeSwap prints CAKE and distributes it to liquidity providers.
By offering extra rewards in CAKE tokens to users who provide liquidity, PancakeSwap can attract capital and build up their liquidity pools, making their platforms more attractive to new users.
The more liquidity is attracted, the more deals will be made. So the volumes passing through this pool will grow. As a result, the protocol and the liquidity provider will earn more on exchange fees. Liquidity mining is part of the business model of the protocol.
However, liquidity mining typically involves a more active role in managing the liquidity in the pools on Decentralised Exchanges (DEX). APY is unstable, and assets in the pool are volatile, as shown in the chart below.
Liquidity mining can be attractive to investors because they offer the potential for high returns. But, it is important to carefully evaluate the risks and potential rewards of any DeFi investment before committing capital. The DeFi market is highly volatile and can be subject to rapid changes in market conditions.
Also, when choosing farmings opportunities, remember the basics of investing in yield farming:
Check the mechanics of the yield farming platform. How does the project make money? A platform printing out tokens as a reward with no underlying revenue mechanism should raise eyebrows.
Check the nature of the required tokens. Find out which tokens are used for farming, and keep in mind that some of them can be hi volatile and dangerous.
What are the pool size and end date of farming? Don’t be the last to enter, or you’d lose on price impacts.
Learn how to enter and exit. What are the chains and coins used for entering and exiting? Will you have trouble with liquidity? Are there any fees or asset freeze periods?
Now, it’s time for a test run. When you’ve chosen a platform that satisfies your criteria, take $10 (or any sum you’re comfortable with) and check how everything works. A test run will, for example, help you see if the APY is displayed correctly. Sometimes, there’s a front-end error when displaying rewards per day.
To learn more about how to choose a secure yield farming platform, check our article.