Yield farming is putting your assets to work. Because what’s better than buying something that’s going up? It going up while also earning a yield. 

In a way, yield farming is kind of like an addiction. If you get into it, you’ll soon be disgusted by even the idea of holding something that only goes up but doesn’t even earn a yield on top.

But what’s happening in the background, and where is the yield coming from? Let’s go through a brief overview of yield farming.

It can be much, but at least it isn’t honest work

So, how does a dead simple yield farming strategy look like? Let’s say you have some BTC and want to earn some yield on it. Let’s also assume that the current APY for supplying USDT to Compound is 25%, while borrowing it costs 20% on Aave. 

First, you convert your BTC to Wrapped BTC (WBTC), a tokenized version of Bitcoin on Ethereum. Then, you take your WBTC, and deposit it into Aave as collateral. Now, you can borrow USDT against it on Aave, supply that USDT to Compound, and boom, you’re earning 5% per year on your Bitcoin (minus the fees and other expenses).

We could call this an arbitrage strategy, sure. But yield farming is a very generic term, and this is probably one of the most straightforward examples. In reality, these chains can become incredibly complicated and involve many different types of liquidity pools (and yields much higher than 5%). Imagine if you could deposit your cUSDT from Compound to a third protocol and earn a yield on top. Then, you can take the token you got from depositing into the third protocol, deposit that into yet another protocol, and so on. This is essentially how yield farming works.

If we have enough DeFi protocols, maybe someday we can create a perpetual motion machine where everything is earning a yield on top of everything else (2008 financial crisis has entered the chat to say nope).

Now, this sounds like an awful lot of clicking ― and that’s hard work! You see, checking interest rates across many protocols, withdrawing, depositing takes a lot of time and effort and may not be worth it, especially if you’re shuffling a smaller account. 

Something easier you can do is deposit your funds in a yield aggregator like yearn, Alpha Homora, Harvest, or many others. (CoinGecko has a dedicated filter for this type of product.) 

The good thing about these aggregators is that they do all this work for you. You could think of it as a bunch of smart and nimble apes handling your funds and putting them wherever they can earn the highest yield. This will vary with each protocol, but usually, you’ll have to pay some kind of performance fee for the convenience. At the same time, this is probably as close to “set and forget” as it gets in DeFi right now. 

Even so, smart contract bugs are still relatively frequent. As we’ve said, these strategies can get very complex. If that’s something that keeps you up at night, you could consider buying decentralized insurance through protocols like Nexus Mutual and Cover.  

So you’re telling me I can just press a few buttons and get free money? Well, yes and no.

Yields exist as a function of token price. 

Basically, if number go up, yield go up. If number go down? Yields probably shrink. We say “probably”, because we haven’t really seen a crypto bear market since the existence of yield farming. In fact, most of the biggest DeFi protocols were built quietly during the last bear market. So, any conclusions about what will happen to yields in a bear market are speculation at this point. 

Even so, it’s quite likely that yields will shrink. Why? There are multiple aspects to this assumption.

One is the cost of borrowing money. If the cost to borrow is high, lenders get paid more, and yields are higher. If money is cheap to borrow, lenders get paid less, and part of the foundation for those money lego pieces we talked about earlier also yields less. Naturally, there may be less interest to borrow money during a bear market, which means it would be cheaper to borrow, which means yields would be lower.

Another thing to consider is just the general risk-taking appetite in the market. You see, getting a new token into as many hands as possible is a really difficult task. At the same time, it’s quite important for a decentralized network to achieve longevity.

This is why many protocols adopt yield farming, or liquidity mining, schemes to distribute new tokens. Basically, the more liquidity you supply to a protocol, the more newly minted tokens you get. At the same time, if people think the protocol is going to be valuable, they just buy the token on the secondary market, and its price goes up. This, in turn, encourages more people to provide liquidity and farm, which encourages more people to buy the token, and so on. Schemes like this are usually accompanied by a really aggressive inflation schedule for the token, where the earlier you get involved as a farmer, the more you earn.

However, what if no one wants to buy the token in the midst of a brutal bear market? Farmers are farming and dumping, meanwhile, no one is buying. The token price drifts down and down into the abyss, dragging down the yield for farming the token with it. So the same mechanism that leads to increasing yields in an uptrend results in decreasing yields in a downtrend.

Another simple argument is that yield is coming from fees. Are you providing liquidity to an automated market maker (AMM) like Uniswap or SushiSwap? Here, take a portion of the fees paid to the protocol by traders. But what if there’s little interest to trade? Less volume = less fees = less yield.

Something you’ll need to consider when providing liquidity in DeFi is impermanent loss. 

We won’t get into it in much detail here, but the bottom line is that if you’re providing liquidity to a pool that has multiple assets in it, and the prices of those assets change a lot in relation to each other, you’re probably exposed to impermanent loss.

This means that you could end up worse in terms of USD value compared to just holding the assets. If you’d like a more technical overview of this phenomenon, check out pintail’s article about it. Also, here’s a neat impermanent loss calculator.

Yield farming may sound like the empty buzzword of the day, but there’s actually real substance behind it. Earning yield is a significant part of traditional finance, and a complex ecosystem around generating yield in this permissionless environment can bring a lot of benefits.

Besides that, yield farming made crypto infinitely more fun. Now, magic internet money isn’t just a jumble of alphanumeric characters in your wallet (although some can appreciate the a e s t h e t i c s of that as well), but it’s collecting vegetables, increasing your army of digital pets, and getting your hands on precious NFTs. 

It’s quite likely that these types of money games will be wildly popular in the future ― especially once the user experience gets to a level where it’s easy to onboard masses of people who don’t even know they’re interacting with crypto.

Find out about the basics of yield farming, how it works and some of the potential pitfalls surrounding it.

A Quick Introduction to Yield Farming

Uniswap has revolutionized on-chain trading. It’s a liquidity protocol on Ethereum that pioneered the automated market maker (AMM) model. With Uniswap, anyone can become a market maker and instantly create a market for any token.

Whereas centralized exchange (CEX) listings have been all the rage in the past, these days, most tokens get listed on DEXes first. Why? It’s much easier to bootstrap liquidity, it doesn’t require any costly partnerships, and can be done relatively quickly.

But what are some of the best practices when it comes to flipping coins on Uniswap? We’ll go through them here.

First, you’ll, of course, need an Ethereum wallet. Since Uniswap lets you trade ERC-20 tokens, you’ll need a wallet that both supports ERC-20 tokens and can talk to Uniswap. The most popular choice is MetaMask. The great thing about it is that you can hook it up to your hardware wallets like Trezor or Ledger. In such a case, your private keys never leave your wallet.

Why is this important? There have been some nasty exploits where hackers could access users’ private keys through MetaMask. So if you want to be on the safe side, connecting a hardware wallet to MetaMask may be among the best options.

How to check your activity in a block explorer

The Uniswap website is basically a frontend for the Uniswap smart contracts. The machinations that happen in the background are, well, in the background. If you want to check what’s happening under the hood, you’ll need to know how to use a block explorer. The most popular one is etherscan.

Etherscan is one of the most useful tools on your Ethereum shitcoin flipper belt. You can track what big holders are doing or what activity is happening with your token. It may take a lot of time to dig through all the information, but it’s there, and it can provide you an edge over other traders. But back to your Uniswap trades.

All you need to do is look up your address on etherscan, and you’ll be able to see your trades. This is especially handy when it comes to unconfirmed transactions. During times of increased activity, you may need to increase your gas bid to get them through. Oh, by the way, let’s talk about gas optimization.

If you’ve been around the crypto space for a while, you know that Ethereum fees can get pretty outrageous sometimes, especially if you want to transact with smaller amounts.

So how do you make sure you pay the smallest fees possible? You have tools like EThGasStation, etherscan's gas tracker, and GasNow. These will tell you the most optimal gas to pay at any given moment. You can also monitor the times when gas is the cheapest.

On most wallets, you can manually enter the gas price you want to pay – they usually tend to get their estimations wrong. Just be very careful not to accidentally fat-finger an outrageously high gas price. Due to the way the gas bidding system works, miners will be more than happy to process your transaction for a big premium. You probably don’t want to be the poor soul who paid almost 25 ETH just to approve USDC on Uniswap!

But sir, how can I do technical analysis (TA) on the latest scam coin? There are a few options out there that take the data from Uniswap and print it on a candlestick chart.

Some examples are ChartEX, DEXTools, and DEX.Vision. This isn’t an exhaustive list – there are many other sites like these, but these can already get you pretty far.

You can also check out Uniswap Info, which is maintained by the Uniswap team. It provides you all sorts of data on how the protocol is doing in terms of value locked, volume, tokens, and token pairs.

As you may already know, the Uniswap protocol is permissionless. This means that there’s no listing process as there would be on a CEX. Any ERC-20 token can be launched as long as someone provides liquidity for an underlying token pair. How can this affect you?

Well, you could think of a CEX as a relatively safe space (the key word here is “relatively”). Sure, bad projects are listed on CEXs all the time, but you can be somewhat sure that even if the coin can dump pretty hard, it probably won’t go to zero from one minute to the next. That’s not the case when it comes to Uniswap.

Remember how we said that anyone could create a market by adding tokens into a pool? They can just as well remove that liquidity. If they do that, there’s a good chance that there’s no market left for your coin anymore, as the liquidity provider just ran away with all the funds in the pool. In other words, you’ve been pwned. Rekt. Rugpulled.

So what can you do to protect yourself against this? Well, a bit of a non-answer is, DYOR. The majority of ERC-20 tokens that exist will go to zero, and it’s up to you how much risk you take on. The fact that the protocol is permissionless has done a lot to democratize access to trading, but it also means the responsibility is in your hands.

On a more practical level, though, you can make sure that you’re interacting with the right token. Let’s say some amazing new token launched that you think is going to change the world. However, while it’s launching on Uniswap, scammers create fake tokens with the same ticker. Are you searching for the token by looking up the name? Well, as it turns out, you may have bought a fake token that’s completely worthless.

There are two simple things you can do to avoid this. The first is Token Lists. If you import a token list that was curated by a trusted entity, such as Uniswap, CoinGecko, DeFiPulse, or many others, you can avoid buying fake tokens.

Another neat feature is also provided by CoinGecko. If the token you want to ape into is listed on CoinGecko, just copy the token contract address and paste it into Uniswap, and you can be sure that you’re buying the real thing. Many projects that first list on a DEX will also provide you the contract address on their website or social media accounts – that’s also a good place to start.

So, these are some basic guidelines for using Uniswap. Now you’re better equipped to trade, will pay less fees, and hopefully will get rugpulled less. Happy trading!

Read this if you're new to decentralized trading platforms such as Uniswap and want a fighting chance.

Tips for Trading on Uniswap

Decentralized exchanges like Uniswap and Sushi have seen an explosion of activity in the last year. These protocols do a great deal to democratize market making and enable anyone to provide liquidity for traders.

If you’ve been involved with DeFi, you’ve most likely heard about impermanent loss. It happens when you deposit funds into an automated market maker (AMM) and the price of your tokens changes relative to each other. The bigger this change is, the larger the impermanent loss.

You need to know about this phenomenon if you want to provide liquidity in DeFi. The high APYs can be attractive, but in most cases, providing liquidity isn’t as simple as just depositing and forgetting about it. Why? You can lose a lot, and it can be very much permanent.

Even so, providing liquidity can be profitable if you know what you’re doing. This is why we’ll go through some key concepts you need to know about before depositing funds into an AMM.

Impermanent loss comes from an inherent design characteristic of current AMMs. It happens when you provide liquidity to an AMM and the price ratio between your deposited tokens changes since your deposit. When we’re talking about a loss, we mean a loss in dollar value compared to simply HODLing the tokens.

While we say it comes from an inherent design characteristic of AMMs, it isn’t necessarily true for all of them. Different AMMs work in different ways. It depends on the individual design, but in most cases, you’re exposed to impermanent loss. As a general rule, if the AMM has a similar design as Uniswap under the hood (and many of them do), you’re likely exposed to impermanent loss.

But wait, why do so many LPs provide liquidity if they’re exposed to this risk? Well, it still may be worth it for them – they can earn trading fees from trades happening in the pool. For example, the Uniswap protocol charges traders 0.3% for each trade, all of which goes to LPs. If the trading volume is very high, even that can be enough to mitigate the effects of impermanent loss. But the really high rewards tend to come from other forms of incentives.

For example, a newly launched protocol may want to incentivize LPs to provide liquidity for its token, so they may drop additional rewards to LPs. Due to the way AMMs work, the more liquidity there is in the pool, the less slippage trades may incur. This is why it’s important to have as much liquidity in the pool as possible from the start, and it’s also the reason why new projects often drop additional rewards to LPs to incentivize providing liquidity.

Let’s see how impermanent loss happens in practice.

We deposit 1 ETH and 1,000 USDC in the ETH/USDC pool on Uniswap. Since the token pair needs to be of equivalent value, this means that the price of ETH is now 1,000 USDC. So, the dollar value of our deposit is 2,000 USD.

Let’s also assume that there’s a total of 10 ETH and 10,000 USDC in the pool. The total liquidity in the pool is 20,000, and we have a 10% share of it.

Let’s say that the price of ETH increases to 4,000 USDC. Arbitrage traders will keep removing ETH from the pool and adding USDC to it until the ratio of the assets in the pool reflects that price. Remember, an AMM has no order book, so it has no idea about the “correct” price. What determines the price of assets in the pool is the ratio between them in the pool. Meanwhile, the liquidity in the pool has to remain constant.

If 1 ETH is now worth 4,000 USDC, the ratio between the ETH and the USDC in the pool has changed. There is in fact 5 ETH and 20,000 USDC in the pool now.

So, what happens if we want to withdraw? As we know, we have a 10% share of the liquidity in the pool. This means that, right now, we can withdraw 0.5 ETH and 2,000 USDC. That’s 4,000 USD, and we made some nice profits from our 2,000 USD deposit, right? Not quite. If we simply hold our original deposit of 1 ETH and 1,000 USDC, we’d now have assets worth 5,000 USD.

So this is how a loss in dollar value looks like as a result of impermanent loss. With that said, we’ve completely disregarded trading fees and other incentives, which could mitigate this loss. But now you understand how this can happen.

What can you do to mitigate this effect? Well, an obvious solution is simply not to deposit into pools where you are exposed to impermanent loss. What are your options?

You can look for pools and AMMs where impermanent loss is small or non-existent. For example, Curve Finance is a good place to provide liquidity without a big risk of IL. Pools that contain assets that remain in a relatively narrow price range are less exposed to impermanent loss. Remember how we said that IL comes from a change in the price ratio of assets in the pool? If this change is small, the risk of impermanent loss will also be tiny.

For example, Curve has a pool for different wrapped versions of BTC. We know that WBTC, renBTC, and sBTC should remain in a relatively small price range compared to each other since they all follow the price of the same asset – Bitcoin. This is why there’s a smaller chance of impermanent loss to liquidity providers.

Another thing you can do is provide liquidity to single-sided pools. In this case, you only deposit one token, and as a result, you’re not exposed to impermanent loss. However, usually, when this happens, the protocol is paying you from token inflation for locking up (and not selling) the token. Whether it’s worth taking that risk is up to your own preference.

Other risks of providing liquidity to an AMM

Impermanent loss is a pretty misleading name. It’s called impermanent because it’s unrealized until you withdraw your funds. If the price ratio of the deposited tokens returns to the ratio at the time of your deposit, the effects of IL are mitigated. Even so, the losses can be very much permanent.

As we’ve mentioned earlier, some liquidity pools are much more exposed to impermanent loss than others. As a simple rule, the more volatile the assets are in the pool, the more likely it is that you can get rekt by impermanent loss. Maybe it’s worth starting with a smaller deposit to see how your funds react to market movements, and then you can be more confident about how this all works.

But what other risks are you exposed to? Well, it depends on the AMM you use, the assets you hold, or even the blockchain you are using. If you’re using wrapped tokens, you’re likely exposed to counterparty risk, as someone has to be trusted with custodying the assets that back the wrapped tokens.

Another thing is, of course, smart contract risk. This technology has only existed for a handful of years, and bugs and exploits are commonplace. Sure, some of the older protocols like Uniswap can be trusted more than a newly launched one, but it’s something to be wary of.

Another risk is rug pulls. If you’re providing liquidity to ETH and some obscure token, there can be a number of things that go wrong. For example, the developers may be able to mint an infinite number of tokens, crash the price, and, as a result, completely demolish your deposit through impermanent loss. They can also pull a considerable portion of funds from the liquidity pool. In both of these cases, you’ll seriously suffer as an LP. Naturally, this risk is largely non-existent with pools containing established tokens, like ETH/USDC.

Impermanent loss is one of the core concepts you should know about when providing liquidity to DeFi protocols. The APYs can be extremely high, but you should be wary of the risks.

Impermanent Loss and the Risks of Being an LP

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A Quick Introduction to Yield Farming

Tips for Trading on Uniswap

Impermanent Loss and the Risks of Being an LP

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