DeFi Yield Farming - A Risk-Benefit Analysis of Earning Crypto with DeFi

DateMarch 25, 2022
Reading Time53 min
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Mathieu Hardy

Chief Development Officer

Yield farming has emerged as a very popular DeFi practice that operates in a similar way to bank loans - but this time, you are the bank and you earn the interest!
Introduction

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The cryptocurrency space is constantly evolving. One of the newest areas where these digital blockchain tokens have shown their potential is in Decentralized Finance (DeFi). As a disruptive technology that is taking aim at traditional monetary systems, DeFi is an interesting proposition as it looks to disrupt how we use our money.


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Decentralized finance is a new way of looking at how we bank, borrow, lend, carry out financial speculation, and even buy insurance. Usually, when undertaking these financial services, we have to seek out banks or financial institutions to offer opportunities, but by decentralizing it - we leave it to the blockchain and open-source, auditable, smart-contracts. You don't really know how your bank operates, but you can be fairly certain that a smart contract will do what's in the code.

Other than just making these traditional financial services decentralized, and therefore more efficient, trustless and effective, there is also potential for new ways to make your money work for you.

Yield farming has emerged as a very popular DeFi practice that operates in a similar way to bank loans - but this time, you are the bank and you earn interest on money (cryptocurrency) that you put into the DeFi system. With yield farming, an investor deposits units of a cryptocurrency into a lending protocol or Automated Market Maker to earn interest or fees from trading or borrowing.

DeFi and Yield

DeFi and Yield farming protocols

Yield farming has become a popular facet of the DeFi ecosystem, but it needs to be made distinct from what DeFi is. DeFi is the entire ecosystem that is still in its infancy but is growing thanks to investment in this system by everyday people and a ton of venture capitalists.

Investing in DeFi would be the usage of the DeFi services that are currently available - like trading on decentralized exchanges, borrowing, and lending crypto assets, and making these actions possible, by providing liquidity in liquidity pools. Yield farming is being on the lookout for the places where the best yield is available so as to be able to maximize the return on your money. Often times by using several DeFi services at once.

Yield offering protocols

Examples of DeFi Protocols Offering "Yield"

With the growth of the DeFi space and its potential, so has there been an explosion in protocols offering DeFi services and crypto yield farming opportunities. Many of these protocols will build on an existing chain, which then gives opportunities for yield farmers to seek out the best earnings they can muster, and within one ecosystem to use several DeFi protocols to compound returns.

If you'd like to start yield farming, you need to have some sort of yield farming strategy. Here are some examples of where you can put your money to work. This is by no means an exhaustive list of yield farming protocols, but it will give you an idea of what the most popular ones are.

Ethereum

Ethereum

By far the most popular blockchain, Ethereum offers a lot of DeFi applications that can be leveraged for yield farming.

Compound

It is one of the most popular and core protocols of the yield farming ecosystem. It enables users to lend and borrow assets. Any user with an Ethereum wallet can provide assets to Compound's liquidity pools and earn the liquidity incentives rewards. The rewards are in-kind (lend USDC and get more USDC back) and in the protocol's governance token (COMP) as a bonus.

MakerDAO

One of the first DeFi projects incorporating a decentralized lending platform to support the creation of DAI, a stablecoin linked to the USD value. The platform is developed on the Ethereum blockchain, where Ethereum smart contracts manage the crypto loans. The users can lock collateral assets such as USDC, ETH, WBTC, or BAT in a Maker Vault to generate DAI against the collateral they have locked in the vault.

Curve

It is an Ethereum based decentralized exchange protocol specifically designed to carry out high-value swaps with stablecoins with low slippage. It also supports DAI, USDC, TUSD, and BTC pairs, enabling users to trade swiftly and smoothly between these pairs.

Uniswap

It is DeFi based decentralized exchange platform that allows users to swap tokens in a frictionless nature. These easy and trustless token swappings assist the yield farmers in executing their strategies or depositing tokens to earn trading fees. On this platform, liquidity providers deposit two tokens holding an equivalent value for market creation. Traders perform trading into this liquidity pool and liquidity providers are rewarded with fees on trades in the liquidity pool they put their assets in.

AAVE

Is an open-source, non-custodial, and widely used decentralized lending platform by yield farmers where the interest is automatically adjusted according to current market conditions.

SushiSwap

Is a popular Ethereum-based decentralized exchange that allows users to swap tokens, earn rewards via yield farming, and more. It was forked from Uniswap.

Alchemix

Is a DeFi protocol that allows for the creation of synthetic tokens that represent the future yield of a deposit. It enables users to retrieve near instant tokenized value against temporary deposits of crypto stablecoins.

Terra

Terra

Anchor

Is an open, permissionless savings protocol, allowing any third-party application the ability to connect and earn interest without restrictions. You can get up to 20% by depositing stablecoins.

Mirror

Is a decentralized platform on the Terra blockchain, created by Terraform Labs. Mirror enables users to mint, trade, and stake synthetic real-world assets including selected equities, ETFs, commodities, and tokens tradable 24/7. If you mint mirror assets and put them in a trading pool, you'll earn fees when people trade.

Solana

SOLANA

Serum

Serum is a complete, non-custodial spot and derivatives decentralized exchange running on an on-chain central limit order book on Solana's mainnet like Uniswap on Ethereum.

Yield Aggregators

A Mention of Yield Aggregators

Because there are varying opportunities to yield farm, and the ROI of different yield farming protocols and opportunities changes daily, Yield Aggregators have also made their way into the ecosystem.

Yield Aggregators leverage DeFi platforms and the yield they offer to maximize profit for a user. In finding the best deals, yield aggregators also simplify and improve user experience. Besides shifting funds between various DeFi platforms with the highest yield, an aggregator navigates the best returns with the shortest commitment and the lowest network costs.

Some popular Yield Aggregators include:

In both of those examples, all you need to do is deposit assets with the yield aggregating smart contract, and they will take care of moving those around to where the best yield farming rewards can be had.

What's "Farming" That Yield?

So What's "Farming" That Yield?

In the most basic way, it is actively seeking out the best opportunities and potential for returns across the DeFi space. It involves moving your funds around to maximize the yields you get for providing liquidity.

Risks of DeFi Yield Farming

Risks of DeFi Yield Farming

As with the cryptocurrency space in general, there are associated risks and more general risks that come with DeFi yield farming.

There is a big reliance on smart contracts to ensure the decentralized nature of DeFi, but these parts of blockchain technology can still be corrupted and have exploits in the code which can lead to issues and loss of funds.

The use of stablecoins is another factor to consider in assessing the general risk of DeFi. Stablecoins are not entirely - or not at all - regulated, and there has been controversy before about the dollar reserves being unaudited and falsified. Moreover, stablecoins can sometimes lose their peg and fluctuate in value.

Of course, as with anything in crypto, the protection of your funds and the integrity of your wallet is important. If you give away your private key, you give away your money.

Finally, network congestion and even the transaction fees associated with a congested network can wreak havoc with your DeFi yield farming plans as it can slow your progress and make you incur additional costs.

Importantly, and specific to Decentralized Finance, If you are borrowing, make sure to watch your collateral ratios or risk getting liquidated.

Watch our webinar to understand the risk surface of investing with DeFi and yield farming.

How To Farm Yield?

How To Farm Yield?

There are a few ways you can begin yield farming, and it is dependent on what chain you want to start on and what opportunities you are seeking. But here is one method to get started.

  • Get metamask or a "wallet connect" enabled wallet such as Argent on Ethereum or Terra Station on Terra. That will be the place from which you interact with DeFi in Web 3. Make sure to backup your key/seed phrase!

Design your DeFi investment strategy, for example:

  • Buy LUNA, use it to borrow on Anchor (which will see you rewarded in ANC tokens at over 100% Annual Percentage Yield), invest the borrowed UST on Anchor (which will see you earn 20% APY in UST).

  • Buy ETH, borrow some DAI on MAKERDAO (get rewarded in MKR), lend that DAI in COMPOUND (get rewarded in DAI & in COMP). Then take the cDAI & the COMP token you've earned, and supply them to UNISWAP to earn a 0.3% trading fee.

  • Buy ETH and WBTC, put them in the Uniswap v2 pool for ETH/WBTC, and you'll earn trading fees. Take the liquidity token, go on MakeDao and borrow DAI against it. Use the DAI to Lend on Aave and earn yield in DAI and AAVE tokens.

Who Farms?

Who Farms?

Farming may be popular, but it is not really a viable opportunity for everyone. Yield farming really rewards those who have a lot of money to put up so it is mostly crypto whales who see the biggest success from yield farms.

The earning percentage is higher than traditional finance, but it is still rather small, especially when including the risks and potential shortfalls that can happen. If you don't have lots of money, the returns will be relatively small.

There are places where liquidity providers can get 1000% APY, but that's often in very small, illiquid tokens. If the project pans out, good for you. But they often do not.

Additionally, if you do it on Ethereum you can end up paying as much as $40 per transaction (when the network is congested), and these fees can eat up all your profits from yield farming.

How Can Osom Help?

How Can Osom Help?

At Osom, we have realized the potential and possibility of DeFi, but we are looking to make it more accessible and open it up to as many people as possible by mitigating some of the risks and lowering fees to increase returns.

To this end, we have DeFi Earn, which aims to alleviate the issues faced in DeFi today, aggregating the industry's best and most reliable stablecoin lending pools into a single intuitive user interface from an EU regulated service provider. By utilizing reputable dollar-pegged stablecoins and proven providers, DeFi Earn mitigates the risks through intelligent diversification.

The platform works by automatically connecting to platforms such as Binance and AAVE, gaining exposure to their stablecoin lending pools, and generating interest on users' assets. Osom converts users' funds into several stablecoins, which are then placed into the lending pools.

Stablecoins can then be converted back to fiat currency at withdrawal at any time as long as the pools are liquid, but they usually are. This enables the Osom users to capitalize on their savings and earn significantly higher yields than in traditional bank accounts. The lowest we've seen is 3.84% and the highest is 10%. Historically, it hovers around 6%.

With DeFi earn, we pay the fees and pool transactions to make it cost-efficient and maximize profits. Additionally, if you get rewarded for providing your funds in the protocol's governance tokens (as is the case now for AAVE), we sell these governance tokens for you to boost your returns.

Conclusion

Conclusion

DeFi yield farming is a fantastic way to make a passive income within the cryptocurrency space, and an emerging path to financial freedom. However, this is an emerging space, and the user experience and inclusivity are not quite there yet.

At OSOM, we want to make DeFi more accessible, easy to use, profitable, and less risky. This is why we have created a service in DeFi Earn that puts the user at the forefront of the DeFi space. By simplifying the entire process, using smart risk-reducing strategies (such as diversification of stablecoins and lending pools), and with us taking on the hard work of yield farming, we can offer steady returns with minimal effort on your side.

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Mathieu Hardy

Chief Development Officer

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