What is Yield Farming?

Yield Farming is the process of putting crypto assets to work in order to generate the largest possible return on those assets.

Similar to finding the best interest rate for your savings account. Crypto assets can be lent to a DeFi application to earn a yield. And in some cases, liquidity providers can also earn a native platform token. The objective of yield farming is to maximize the total amount of yield, while minimizing all the downside risks.

It is also possible to recursively invest tokens and stack yields across different protocols. Thus, multiplying a liquidity providers interest.

The risk of Yield Farming

Smart Contract risk: Smart contracts are prone to hacks and exploits
System design risk: Many protocols are just emerging and many economic incentives may be gamed
Liquidation risk: Collateral is subject to price volatility, and debt positions are at risk of becoming undercollateralized in market swings. Liquidation mechanisms may be very inefficient for many of these new protocols
Bubble risk: Network tokens are partially priced based on future use of the protocol. But the use of the protocol today is dependent on assumptions of the future value of the tokens. This circular dependency may generate a bubble