Decentralized finance (DeFi) exists to democratize the financial system by eliminating central authorities like banks. Did you know that cryptocurrency holders can serve the very same role that banks traditionally did? Here is what yield farming in DeFi is and how it works.

Broadly speaking, yield farming is putting crypto assets to work in order to potentially maximize returns on those assets. The best thing is that anyone can do it, meaning that yield farming is an alternative way to earn passive income – by lending coins or tokens through decentralized applications (dApps), for example, DEXs (decentralized exchanges), crypto wallets, and more.

Consider discovering decentralized money protocols.

Users lending their crypto assets are known as liquidity providers (LPs). First, LPs need to lend their coins or tokens to a liquidity pool – a collection of funds locked in a smart contract-based dApp.

Once the coins or tokens are locked into a liquidity pool, LPs are awarded an interest – sometimes, fees – generated from the DeFi platform the liquidity pool is on.

Estimated yield farming returns are calculated based on annual percentage yield (APY). In simpler terms, it is the rate earned on an investment in a year that takes into account the effects of compounding interest.

Yield farming includes becoming an LP as well as lending, borrowing, and staking practices.

For instance, users deposit coins to a DEX to provide trading liquidity. Exchanges then charge a small fee to swap the tokens, which are paid to LPs. What’s more, fees can also be paid in new liquidity pool tokens.

Lending is a basic practice in traditional finance, and also very popular in DeFi, where anyone can become a lender. And not just in terms of yield farming. Utilizing smart contracts, you can lend your crypto assets to like-minded borrowers and earn interest.

When it comes to borrowing, coins or tokens can be placed as collateral on the loan, and the borrowed funds can then be used for a variety of purposes – like lending to other crypto enthusiasts or staking to name just a few.

Staking crypto has been on the rise since 2020, and there is a good reason for this: staking is a low-risk practice of purchasing and holding or locking funds in a crypto wallet, making them available for use in the Proof-of-Stake (PoS) process.

We encourage you to find out more about how staking works by reading our Guide to Staking Crypto.

Coinmetro is a fully-licensed FinTech ecosystem that offers you an opportunity to get annual staking rewards for just holding coins on its platform. Sign up to our platform to start earning passive income the smart way.

Yield farming is becoming more mainstream with the rising adoption of crypto. The concept of lending with interest for profit has been dominating traditional finance for a long time, and yield farming is just a digitized and more profitable version of it.

At all times, keep in mind that although yield farming is a potentially profitable undertaking, there are certain risks involved. The crypto market is extremely volatile, and a lot can happen while your crypto assets are locked.

To learn more about decentralized finance and passive income opportunities, join the discussion on our Discord and Telegram channels. Take advantage of our ever-growing community, find inspiration, and exchange ideas with like-minded people.