What is DeFi Yield Farming? Decentralized Finance, shortly termed as DeFi is an open-source protocol that provides permissionless and fast financial services. The process by which users provide liquidity to DeFi open-source protocols and get rewards is termed as DeFi Yield Farming.
In simple terms, the process of yield farming carried out on platforms that are built using DeFi protocols offers native DeFi tokens of that particular platform and this process is known as DeFi Yield Farming.
We already know that DeFi has been a trending business topic from late 2020, and now this DeFi Yield Farming is sparkling as a light in every headline of recent crypto news. This shows that DeFi Yield Farming has caught sight of crypto wizards and it will make them shift to the next level in the crypto market sooner.
What are DeFI Liquidity Pools? Liquidity Pools are smart contracts that lock up tokens or assets to facilitate trading by providing high liquidity. Liquidity Pools also are known as pools of tokens or pools of assets offers users better returns as compared to money markets but involves certain risks.
Uniswap and Balancer are the most popular DeFi platform termed as the largest liquidity pools which provide liquidity providers reward for adding their assets to the pool.
Who are DeFi Liquidity Providers? The process of yield farming is nothing without Liquidity Providers. The users who stake their assets in the liquidity pools are known as liquidity providers. This process of collection of orders facilitates trading in cryptocurrency through the creation of a market. Thus, liquidity providers are also termed as market makers, as they supply what buyers and sellers want to trade.
How Does DeFi Yield Farming Works? Yield farming referred to as Automated Market Maker, is nothing without the involvement of liquidity providers and liquidity pools.
Here let us look at the working process of yield farming.
First and foremost, the liquidity providers deposit or send their assets or funds to the liquidity pool. This liquidity pool provides a marketplace where users or LPs can lend, borrow or exchange their tokens or assets. These platforms collect fees which are then paid back to the liquidity providers based on their share of the liquidity pool.
This is how a yield farming process takes place on any platform. However, working can vary with different technologies and approaches. The funds deposited are mostly stablecoins pegged to USD. DAI, USDT, BUSD are the most commonly used stablecoins in DeFi yield farming.
How Are Returns Calculated in DeFi Yield Farming? The Estimated returns in Yield farming are calculated on an annual basis. The most important metrics in the calculation of returns in yield farming are Annual Percentage Rate (APR) and Annual Percentage Yield (APY).
The common difference between both APY and APR is that APY accounts the effect of compounding while APR does not. Compounding refers to reinvestment profits to generate more returns.
Annual Percentage Yield (APY) The annual rate of return charged on borrowers and paid to providers subsequently refers to Annual Percentage Yield.
Annual Percentage Rate (APR) The annual rate of return imposed on borrowers and paid to the investors is termed as Annual Percentage Rate. Since APR and APY come from legacy markets, DeFi should find its own metrics for the calculation of returns in yield farming.
This is how the returns are calculated in the DeFi Yield Farming.
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