Yield Farming Basics
Yield farming is earning rewards by providing liquidity to DeFi protocols. It can be lucrative but comes with significant risks. Here's what you need to know.
Yield farming involves smart contract risk, impermanent loss, and token value risk. Only use funds you can afford to lose completely.
What is Yield Farming?
Yield farming means putting your crypto to work to earn more crypto:
- Deposit tokens into DeFi protocols
- Protocol uses your tokens (lending, trading, etc.)
- You earn rewards (interest, fees, tokens)
- Rewards often expressed as APY (Annual Percentage Yield)
Types of Yield Farming
1. Liquidity Providing
- Add tokens to trading pools (e.g., Uniswap)
- Earn trading fees from swaps
- May receive LP tokens to stake elsewhere
2. Lending
- Deposit tokens in lending protocols (e.g., Aave)
- Earn interest from borrowers
- Lower risk than liquidity providing
3. Staking
- Lock tokens in protocol
- Earn protocol tokens as rewards
- Often used to incentivize liquidity
Understanding APY
| APY Range | Risk Level | Typical Source |
|---|---|---|
| 1-5% | Lower | Stablecoin lending |
| 5-20% | Medium | Major token pools |
| 20-100% | High | New pools, incentivized |
| 100%+ | Extreme | New/risky protocols |
If APY seems too good to be true, it usually is. High yields come from new token emissions that often crash in value, or from unsustainable models.
The Risks
Smart Contract Risk
- Bugs in code can lose all funds
- Even audited contracts can have vulnerabilities
- Billions lost to hacks historically
Impermanent Loss
- Loss from price divergence in LP positions
- Can exceed fee earnings
- See our impermanent loss guide
Token Value Risk
- Reward tokens often lose 90%+ value
- High APY in worthless tokens = no profit
- Farm and sell or farm and hold is critical decision
Rug Pull Risk
- Anonymous teams can drain contracts
- Stick to established protocols
- Check if contracts are verified and audited
Getting Started Safely
Step 1: Start Small
- Begin with established protocols (Aave, Compound, Uniswap)
- Use small amounts until comfortable
- Understand gas costs vs. position size
Step 2: Learn Gas Optimization
- Ethereum gas can eat profits on small positions
- Consider Layer 2 (Arbitrum, Optimism) or alt chains
- Time transactions for low gas periods
On Ethereum mainnet, you typically need $1000+ positions for yield farming to be profitable after gas. Layer 2s allow smaller positions.
Popular Yield Farming Platforms
- Aave - Lending/borrowing, established
- Compound - Lending, Ethereum native
- Uniswap - DEX liquidity provision
- Curve - Stablecoin-focused DEX
- Convex - Curve yield booster
Yield Farming Strategy
- Diversify across multiple protocols
- Regularly harvest and compound
- Monitor position health
- Have exit strategy ready
- Track all transactions for taxes
Yield farming creates many taxable events. Every harvest, swap, and withdrawal may be taxable. Keep detailed records.