So you’ve been in the crypto game for a few months and are ready to really give DeFi a real college try and thanks to DeFi you are essentially your own bank so now you get to do things that banks do like borrow assets at one interest rate and then loan them out at a higher one $$$$.
Now let’s remember, crypto borrowing is different than the regular mom and pop borrowing that you’re used to, meaning, it’s overcollateralized. I.E to borrow these crypto-assets you have to already possess more than what you’re borrowing. So if you want to borrow $8,000 worth of an asset you need to have at least $10,000 and so on. Also, it’s important to remember and permanently get used to/immediately love that sense these Defi platforms rely on smart contracts if you fulfill the collateralization requirements you can get started in just a few minutes.
So, your assets are going up. That’s great, good for you. But what if you could also be earning yield on these assets in addition to them going up?
Ok, so what’s yield?
So you in finance you have yield and you have return. Return is something we are all familiar with. You bought an asset at 5 dollars and now it’s 10. With yield, you bought that same asset and are using it to earn income in the form of interest most likely. Another example to describe yield vs return is real estate. Say you own a home, the value of your home increasing or decreasing vs its value when you bought it is the return. If you decide to rent that home, the income you generate from the rent is the yield….kind of, in a simplified way
Now, so yield farming is…
Let’s use a dead simple yield farming example to explain:
Say you have some Bitcoin sitting in your wallet on Coinbase and want to start earning yield on it. You see that the current APY for supplying Tether on Compound is 15% while the APR for borrowing is 10% on Aave.
So, you take your BTC and convert it to WBTC which is the tokenized version of Bitcoin on Ethereum and post it on Aave as collateral and borrow Tether then you turn around and go to Compound and supply that Tether and receive your 15% APY. The 5% difference in your yield on that Bitcoin.
This is a very straightforward example. Yield farming can get significantly more complicated. You could deposit your Tether from Compound to a third protocol and earn a yield on top of it. Then, you can take the token you got from depositing into the third protocol, deposit that into a fourth protocol, and so on.
A quick word on yield aggregators
Comparing interest rates across platforms is a lot of work and this is supposed to be passive!
Luckily for us, there are yield aggregators like yearn.finance, and others that will do the work for you. These aggregators basically are robots that take your capital and place it wherever it can earn the highest yield for a small convenience fee.
Unfortunately, as with most things, there is a catch.
Important loss is another phenomenon of financial wizardry that we won’t go into much detail about but it can be summarized by if you are providing liquidity to a pool that consists of multiple assets like the ones used in yield farming, then if the prices of those assets change a lot in relation to each other you would be exposed to impermanent loss meaning it would have been better in USD terms to have just held the assets.
Risks aside yield farming is a tantalizing opportunity that is worth dipping your toe in.