What is yield farming, and how can I be part of this new trend?
This being the latest trend in cryptocurrencies, investors in the space need to understand what it is and how it works.
Investing in ETH is not Yield Farming; lending ETH in Aave or CREAM to obtain a return beyond the increase in price of ETH is Yield Farming.
Yield Farming is the process of obtaining a higher return on capital than it would with a simple increase in price, giving it a much more productive use.
How and where can I yield farm?
There are many projects that offer these types of benefits, with different levels of risk, from low to very high. Some of the safest and most established are Compound and Aave, which are the main loan protocols in crypto, but the lower the risk, the less return on your investment they offer you.
This is why a large number of projects have arisen that seek to maximize profits at higher risk, but these returns can be so good that it is inevitable to pay attention to them, with these the risk can be so great that it is better not to invest what you are not prepared to lose.
There is a wide range of projects of this type, but some of the most popular are SushiSwap, Pickle Finance, Creed Finance, among others. These are becoming so common in fact that a huge number of copycat projects come out every day, and they are almost all identical aside from the graphic design.
What are Liquidity Providers and Liquidity Pools (LP)?
This is one of the concepts that has emerged with the now popular DEX or Decentralized Exchanges and the AMM or Automated Market Makers, and this allows for passive income using the decentralized Ethereum network.
On AMM-based decentralized exchanges, the traditional order book is replaced by liquidity pools that are pre-funded for both assets of the trading pair utilizing smart contracts. The liquidity is provided by other users who earn passive income through trading fees based on the percentage of the liquidity pool that they provide.
But how do you earn passive income this way?
Simple, they add or deposit funds in a liquidity pool, which are Smart contracts that hold funds. In exchange for providing funds and liquidity to the group, these LPs receive a reward.
These rewards are obtained from the fees of the platform used and are usually received in the same currency in which they provide liquidity to the liquidity pool.
Let us give an example in which we join a liquidity pool of the CREAM / ETH pair, in this case we must supply 50% of the amount we want to invest in CREAM and the other 50% in ETH.
We will then receive a token that represents our share of the complete liquidity pool of these coins depending on how much money we have supplied. This percentage tells us the profits that we are going to get from the fees generated in that liquidity pool.
For example, if the entire Liquidity Pool has 100,000 USD, and we provide 10,000 USD, in this case we will represent 10%. If in this pool, 2,500 USD in fees were generated in 1 week, which the people who traded this pair paid, we would be receiving 10% of this amount, which would be 250 USD.
We would be receiving this money in the tokens that we have supplied the liquidity for, in this case Ethereum (ETH) and CREAM.
In this way, in a week we would be generating 2.5% of the 10,000 USD that we put in passively.
(Please note that these numbers are totally arbitrary and do not represent what you could actually generate.)