Yield farming is a strategy where decentralized finance (DeFi) deposits are used as investment opportunities, allowing users to earn protocol-related rewards such as interest, trading fees, or newly minted tokens.
An example of yield farming is earning rewards for providing liquidity to a DEX exchange liquidity pool when depositing two or more tokens. The rewards might be a share of the trading fees. Similarly, a user may lend assets through a DeFi lending protocol, earning interest from those who borrow the assets. Newly issued tokens may also be given as a reward for the liquidity provider.
Yield farming returns are often shown in the form of an annual percentage yield (APY), but returns are variable and depend on market conditions and liquidity. Additionally, yield farming rewards may change when protocol incentives are modified. Risks shouldn’t be underestimated as well and may involve impermanent loss or protocol failure. As a rule of thumb, the higher the marketed incentives, the greater the potential risk, but risks should be assessed on a case-by-case basis.
