What is Yield Farming?
Yield farming can earn high returns but also has significant risks including impermanent loss, smart contract bugs, and rug pulls. Only use funds you can afford to lose completely.
How Yield Farming Works
The Basic Concept:
You deposit your crypto into a "liquidity pool" that others use for trading. In return, you earn:
- Trading fees - A cut of every trade
- Token rewards - Extra tokens as incentives
Liquidity Pools Explained:
1. You deposit $500 worth of ETH + $500 worth of USDC
2. Someone swaps ETH for USDC using your liquidity
3. You earn a fee (0.3% of their trade)
4. Plus: You might earn bonus tokens (like UNI)
Common Yield Farming Strategies:
- Simple LP - Provide liquidity, earn fees
- LP + Staking - Stake your LP tokens for extra rewards
- Lending - Deposit to lending protocols, earn interest
- Yield Aggregators - Auto-compound across protocols
Understanding Impermanent Loss
This is the biggest risk in yield farming that many beginners don't understand.
When you provide liquidity, if one token's price changes significantly relative to the other, you end up with LESS value than if you had just held both tokens.
Simple Example:
- You deposit: 1 ETH ($2000) + 2000 USDC = $4000 total
- ETH price doubles to $4000
- If you HELD: 1 ETH ($4000) + 2000 USDC = $6000
- In LP pool: ~0.707 ETH ($2828) + 2828 USDC = $5656
- Impermanent Loss: ~$344 (5.7%)
When Impermanent Loss Is Worst:
- Large price divergence between the two tokens
- Volatile token paired with stable token
- One token moons or crashes
When Impermanent Loss Is Minimal:
- Stable/stable pairs (USDC/USDT)
- Correlated assets (stETH/ETH)
- Prices stay relatively stable
Use impermanentloss.net to calculate potential IL for different price scenarios before you LP.
Finding Yield Farming Opportunities
Popular Platforms:
| Platform | Network | Type |
|---|---|---|
| Uniswap | Ethereum, L2s | DEX LP |
| Curve | Multi-chain | Stablecoin LP |
| Aave | Multi-chain | Lending |
| Convex | Ethereum | Yield Boost |
| Yearn | Ethereum | Aggregator |
Research Tools:
- DefiLlama - TVL data, yield comparisons
- Coingecko - Pool APY data
- Zapper/Zerion - Portfolio tracking
If you see 1000%+ APY, ask yourself:
- Where does this yield come from?
- Is it sustainable?
- What are the token's economics?
Often, high APY = high inflation = price drops = you lose money
Risk Management
Major Risks:
- Smart contract bugs - Code can be exploited
- Impermanent loss - Lose vs just holding
- Rug pulls - Developers steal funds
- Token value drops - Rewards become worthless
- Platform insolvency - See: Celsius, BlockFi
How to Farm Safer:
- ✓ Only use audited protocols
- ✓ Stick to established platforms (Uniswap, Aave, Curve)
- ✓ Start with stablecoin pairs (lower IL risk)
- ✓ Never farm with more than you can lose
- ✓ Understand what you're investing in
- ✓ Diversify across multiple protocols
If you're new to yield farming, start with:
1. Stablecoin lending on Aave (lowest risk)
2. ETH/stETH pool on Curve (correlated, low IL)
3. Stablecoin LP on Curve (minimal IL)
Only advance to riskier strategies after you understand these.
Many yield farmers lose money after accounting for:
- Impermanent loss
- Gas fees (especially on Ethereum)
- Token price drops
- Time spent managing positions
Sometimes the best yield is just holding BTC/ETH.