How does Yield Farming work and what are the opportunities and risks involved?
When we look back and think of all the defining moments in the decentralized journey, the establishment of DeFi platforms is among the key moments that stand out. DeFi is arguably the powerhouse behind the impressive innovations we have seen thus far. Among the results of the great DeFi boom is the emergence of yield farming. But exactly how does yield farming work, and are there any risks?
The alternative method of wealth generation introduced by the success of DeFi platforms is now among the significant attracting factors of the decentralized industry. DeFi is, in fact, the reason for our existence in this marketplace and among the very reasons our push for a new paradigm among the DEXs in crypto.
The underpinning for DeFi is that anyone can participate in the system. It is organized in a decentralized fashion, which means it is globally seamless and there are no special privileges. Anyone in the world has the same access to the underlying infrastructure.
How does Yield Farming work?
Yield farming, or liquidity mining as known by others, generates cryptocurrency income from current cryptocurrency holdings. Simply put, one makes more cryptocurrencies by locking up their holdings of cryptocurrencies. It sounds like staking from a broader perspective; however, as you get into the details, some stark differences emerge.
One of the major differences is the requirement of liquidity providers (LP) in yield farming who add funds to liquidity pools. Therefore, these liquidity providers become an important, if not the most critical part of liquidity mining.
Unfortunately, the downside of liquidity mining is the possible loss that LPs are likely to incur due to risks associated with existing platforms.
Lack of foresight creates risks
When attempting to understand how Yield Farming works, an individual must be aware of the risks. One of the significant risks for LP when yield farming is Impermanent Loss. Impermanent loss is the loss in value of cryptocurrency an LP experiences while withdrawing their tokens due to the unexpectedly low value of the tokens. For instance, an LP may deposit 500 $QRS in a liquidity pool at a value of $1 per $QRS and earn 300$QRS from the yield farming proceeds. However, they may end up incurring losses if the value of $QRS drops to $0.50 per $QRS owing to market factors that could potentially be avoided. Other risks include malicious software, smart contract risk, and project risk.
Any platform can quickly mitigate a project- smart contracts and malicious software risks. For impermanent loss, a more ingenious method is required to avoid such losses. Fortunately, we were able to produce a system that reduces, and in some cases, entirely stops impermanent loss on our platform. We crafted our platform such that LP gets as close to 100% of their generated cryptocurrencies as possible.
Dealing with impermanent loss
Having analyzed the sources of impermanent loss, it was easier to develop our platform based on our findings and recommendations. One of the contributing factors to the impermanent loss we identified was price volatility. We, therefore, designed our platform with tools that would help mitigate price volatility and making it easier to understand how Yield Farming works for potential farmers.
Firstly, we established smart pools. Our motivation behind smart pools was to give our community the freedom to determine whom they will trade with and how they will conduct their trades. Smart pools have innovative configurations that allow our users to create their liquidity pools and decide the criteria for admitting participants and parameters for participation.
The freedom allows our community to operate independently, giving them as many options as possible for trading, which helps maintain the stability of our ecosystem. Our system removes the overreliance on the general market, bringing trading closer home to pools composed of traders of a somewhat similar mindset. With liquidity sorted out, we were comfortable that Vegaswap would never be affected by any serious token price volatility.
To further reinforce our platform against impermanent loss, we added dynamic pricing curve features that help determine the transaction costs on our platform. Now, transaction costs can easily influence the value of an asset by influencing trading in a platform. High transaction costs limit trading, whereas low transaction costs encourage trading.
Our dynamic fees considers prevailing market conditions, assesses their influence on transaction prices, and produces the lowest price possible that accommodates both market factors and the need for low transaction rates by our community.
We also opted for a multi DEX platform to increase the trading options on Vegaswap. Currently, our platform supports Ethereum based tokens and BSC tokens. Polygon and Solana, will soon be added, and other protocols as well. The increased options will, in turn, increase participation within our ecosystem which can help prevent price volatility and ultimately impermanent loss.
Other risk factors
As mentioned before, the other risk factors are project risk, smart contract risk, and malicious software. These three risks are adequately dealt with by our robust proposed system that will undergo extreme security tests to ensure that our community is safeguarded against such simple risk factors.
DeFi is the heart of blockchain technology; therefore, it needs as much support from our respective communities. As Vegaswap, we chose to make a platform that accommodates any potential decentralized platform to provide a means through which they can get adequate support and allow users to understand how Yield Farming works.
As blockchain seeks to attain higher standards, the entire blockchain community must band together wherever possible to ensure that the ethos of blockchain is prioritized by supporting those platforms with the potential to keep the true spirit of blockchain.
Vegaswap is a user-centered automatic market maker that leverages multichain technology, providing users with a wide range of DeFi and cross-chain applications through its platform. It supports and enables seamless token earnings through customizable liquidity pools, dynamic pricing, and an intuitive UI.
Vegaswap makes the work of LP providers efficient and profitable by creating provisions for unique smart pools, providing analytics tools, and reducing impermanent loss with adaptive spread.
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