As of 5 July 2022, the market cap of DeFi is over $38 billion with a total trading volume of more than $3.8 billion within the 24 hours. The numbers show that DeFi is still booming despite the “deep” that has rocked the crypto market so far this year—a large number of traders are executing trades and sealing deals in the market. And to think that DeFi connects lenders and borrowers in peer-to-peer manner “trust-lessly” without the mediation of a third party, like a bank, makes it even more appealing to people who are willing to deposit funds to liquidity pools for profit. This explains the growing popularity of yield-farming in the DeFi ecosystem.
How Much Do You Know about Yield-farming, the New Way of Making Money in the Defi Ecosystem?
Yield-farming (or liquidity mining) is a type of investment in the DeFi ecosystem in which you, the farmer, can provide liquidity (or deposit fund) to a DeFi protocol and have it locked up for a reward subsequently. Yield-farming allows you to provide liquidity to a particular DeFi protocol and rewards the gesture with either the native token of the protocol, incentives, interests, or additional cryptocurrency. Yield-farming runs on blockchain-based smart contracts that offer decentralised financial services to both the borrowers and the lenders in the ecosystem.
Yield-farming is one of the unique trends in the DeFi ecosystem that has captivated the interest of crypto enthusiasts: It is a new way of earning rewards through cryptocurrency holding using permissionless liquidity protocols. Through it, you can stake and lend crypto assets within DeFi protocols. Although it was originally conceived to be a source of passive income for interested crypto investors, yield-farming has become a routine work for many people with the emergence of a large number of blockchains and platforms for various strategies. It is simply the future of decentralised finance.
For inexperienced farmers, decentralised finance can be complicated, and yield-farming even terribly arduous: They will have to understand how blockchain works, which tokens are on which blockchain, where yields are generated, and how they are generated. They are inundated by numerous offers of liquidity pools from which they are expected to choose the best one to farm on. What is arguably most challenging for inexperienced farmers is they are required to log in every day to the blockchain they chose in order to check the status of their liquidity and to manually calculate their returns.
Not only that, in order to earn more rewards in yield-farming, the farmers (or the crypto investors) are required to deposit the reward they have earned on one DeFi protocol to another DeFi protocol. This process is known as cross-chain farming. Although it provides more rewards to the farmers, it demands lots of effort and monitoring from them. They have to track trends on different blockchains to determine the best farming strategies to adopt. In addition, they have to manually calculate the associated risks with each strategy.
Cross-chain farming is complex and currently limited by the capabilities of contemporary cross-chain protocols; they place the burden of yield-farming on the farmers themselves who may not have the time to
- provide liquidity to blockchain that is best for their farming desires,
- navigate different blockchains in order to maximise profit,
- learn how to choose from numerous pool offers the best pool to provide liquidity,
- monitor their liquidity and manually calculate their returns on investment, or
- manually transfer their liquidity to another DeFi protocol when there is a better offer or a drop in profitability.
But What If There Is an Automatic Yield Protocol That Can Take the Weight of Yield-farming off the Shoulders of the Farmer and at the Same Time Guarantee High Profit?
It would be nothing short of wonderful! An automatic yield protocol would allow farmers to provide liquidity from any place of their choice in whatever token. The farmers would not have to worry about which blockchain to farm on that will yield good rewards. The automatic yield protocol would take care of this problem and at the same time find the best place to invest the farmers’ liquidities in order to make maximum profit. Moreover, if the yield in profit falls in one blockchain, the automatic yield protocol would be able to move the farmers’ liquidities to another more suitable blockchain. In short, the automatic yield protocol would take care of the complex farming strategies associated with cross-chain farming.
Like other lending services, Lending protocols require the user to deposit collateral. When the liquidation threshold is reached, the user runs the risk of having the collateral sold off at an unfavourable price. For this reason, only people who have lots of capital (the whales) are the ones who profit from yield-farming. However, the automatic yield protocol would allow the user to sell part of the collateral that is necessary to cover the drawdown in exchange rate difference when the liquidation threshold is reached, while the user keeps the remaining assets.
This will ensure that not only the whales who have lots of capital to deploy can benefit from yield-farming—but everybody, because everybody would be in control of their investment, while the automatic yield protocol does the farming for them. In essence, the automatic yield protocol would
- allow yield-farmers to farm easily on multiple blockchains,
- have single protocol to which the farmers can deposit their liquidity in one place,
- incorporate liquidity pairs that are monitored, and
- perform all the complex operations that the farmers have to do manually.
What Security Features Should the Automatic Yield-farming Protocol Have?
The raging popularity of DeFi has also exposed it to attacks, like hacks, thefts and fraud: According to Certik, a blockchain security firm, $1.6 billion was lost in DeFi in the first quarter of 2022. On 24 June 2022, the Harmony team of the Horizon Bridge announced on Twitter that they had lost $100 million in altcoin. You can see that security is a serious issue in DeFi. Therefore, the automatic yield protocol should take security very seriously to ensure safe farming. Accordingly,
- security audits of each feature that affects smart contracts should be effectively implemented in the the automatic yield protocol, and
- a notification system should be built in it to alert any suspicious transaction.
The automatic yield protocol should be composable: It should be able to explore the capabilities of each liquidity—for example, Uniswap, Maker and Polkaswap—and build bridges among them. It should be able to use multipart strategies to devise a plan for safe earning. Basically, the automatic yield protocol should be able to choose the best farming strategy for farmers while securing their liquidity from hacks, theft, and abuse. This will increase earning in the DeFi ecosystem and incentivise more people to grow with it.