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In the early days of crypto assets, there were only a few ways to make gains. One way was trading. The other way was to simply hold onto the assets, in the hope their price would rise to an unexpectedly high rate.
Later, some forms of storing up crypto assets for interest gains appeared. Some of those projects turned out to be scams. Most notoriously, Bitfinex relied on a constant inflow of new funds, as well as Bitcoin appreciation, to be able to support its Ponzi scheme.
The crypto market, however, did not stand to see digital coins and tokens sitting idle and waiting for a pump. In the summer of 2020, a form of decentralized finance appeared which promised to create more predictable, constant money flows based on trading and lending algorithms. Thus, owners of whale-sized wallets could see some of their assets make gains, while others could take out loans for trading positions.
One of the key elements of this decentralized finance ecosystem is yield farming. Most generally, it means the locking up of digital coins or tokens in dedicated smart contracts. Those smart contracts can then generate liquidity for multiple other projects, including lending contracts, decentralized exchanges, or the creation of dollar-pegged coins and tokens.
Yield farming is a high-return, high-risk strategy to reap crypto gains. Some of the risks are technical, including smart contract exploits or transaction mistakes. Funds locked in a yield farming protocol are not guaranteed. When the coin or token is in a highly volatile pair, the yield farmer may end up losing funds, and only hope for a market recovery to recoup the loss and return to profitability.
Yield farming is here to stay after decentralized finance (DeFi) grew to hold above $25B in all projects, vaults, and smart contracts.
We looked at some up and coming projects, to estimate the risk and potential benefits of providing liquidity and taking up yield farming instead of a buy and hold strategy.
SyncBond is a project taking in crypto funds and issuing crypto-based bonds. The SYNC token, which is being currently released in a year-long process, will be one of the main tools to generate passive income. Unlike usual yield farming projects, the SYNC token will not be locked directly within liquidity provider pools. Instead, SyncBond has chosen to create a crypto bond.
This is a separate, fully crypto-based financial instrument, which at the time of issuance combines equal dollar values of SYNC tokens and UniSwap liquidity tokens. The bond exists on the Ethereum blockchain as a non-fungible token (NFT) and can be traded on the secondary market.
The advantage of a bond is that it holds both sides of a liquidity pair. This ensures that SYNC will always be paired with some amount of UniSwap liquidity tokens and that the pair will not see its liquidity dry out. The crypto bond has the advantage of holding both assets, as a potential longer-term buy and hold strategy.
Impermanent loss is still possible with crypto bonds, though SyncBond attempts to mitigate that by ensuring stable liquidity.
Impermanent loss happens most often when traders attempt arbitrage between the UniSwap exchange pair and another exchange where assets have higher prices.
UniFarmer is another one of the up and coming yield farming projects. It is still in the token sale stage, arriving months after some of the hottest yield farming projects of 2020.
UniFarmer is the answer to a dilemma for small-scale investors. Choosing a liquidity pool and moving assets on one’s own can be difficult or prohibitively expensive, due to high Ethereum gas fees. UniFarmer chooses a model of pooled, automatic yield farming that optimizes yield for most users.
The UNIF token, with a total supply of 150,000, will aim for a small-scale liquidity pool initially, of just around 80 ETH. Buying UNIF at 500 tokens per 1 ETH is similar to an ICO, except the asset will be immediately liquid through a decentralized yield farming smart contract. UniFarmer is a smaller project compared to some of the leading DeFi startups. However, even small projects can achieve significant returns from yield farming.
JuiceSwap is an already fully functioning project complete with staking, yield farming, a non-fungible token market and a decentralized exchange. Launched in January 2021, JuiceSwap uses the principle of automatic market makers, or algorithmic trading.
JuiceSwap is one example that in the world of DeFi, there is still place for new platforms. The basics of JuiceSwap trading use the already well-known formula of UniSwap for automatic market-making. The formula, X*Y=K, where K is constant, is used to establish a ratio between a pair of crypto assets.
JuiceSwap uses the usual path of unlocking MetaMask or WalletConnect to access the yield farming features.
Venus Protocol is another relatively new decentralized finance project. Its distinguishing feature is that it is based on Binance Chain, avoiding the congestion and fees of the Ethereum network.
Venus Protocol moves away from direct yield farming, but serves as one of the underlying sources of funds, which can then move into yield farming. The protocol relies mostly on dollar-pegged stablecoins, where arbitrage rarely leads to big price swings and big potential losses or liquidations.
Venus Protocol relies on a double token scheme. One of the tokens, VTU, is a dollar-pegged stablecoin. The other, VToken, is used as collateral to mint VTU or to borrow other funds. Dollar-pegged tokens allow for safer arbitrage and more predictable yields in some farming protocols.
Yield farming remains relatively complex. Choosing the right project means being aware of the high-level market risk still inherent to crypto assets. Yield farming has gone through spectacular booms and busts.
Some of the projects manage to recover, but the losses have been absorbed by the less fortunate traders or farmers.
The appearance of new projects aims to mitigate some of the riskiest sides of yield farming. As funds locked in various liquidity vaults grows, sometimes doubling within the course of a few weeks, decentralized finance is already showing signs of being here to stay.
The trend for growth in funds locked also signs to promising times for yield farming.
While the initial hype has worn off, and there were some stark warnings and losses in the sector, new projects keep discovering better mechanisms to extract value from fast algorithmic trading, thus opening constant opportunities for yield farmers.