What is yield farming ?
When you deposit money in a bank, you’re effectively making a loan, for which you get interest in return. Yield farming involves lending cryptocurrency. In return, you get interest and sometimes fees, but they’re less significant than the practice of supplementing interest with handouts of units of a new cryptocurrency. The real payoff comes if that coin appreciates rapidly. It’s as if banks were luring new depositors with the gift of a tulip — during the Dutch tulip craze. Or a toaster, if toasters were the object of wild speculation and price swings.
How does it work ?
The most basic approach is to lend digital coins, such as DAI or Tether, through a dapp such as Compound, which then lends the coins to borrowers who often use them for speculation. Interest rates vary with demand, but for every day’s participation in the Compound service, you get new Comp coins, as well as interest and other fees. If the Comp token appreciates — and it’s more than doubled in value since mid-June — your returns skyrocket as well.
What are the risks ?
Theft, for one. The digital money you lend out is effectively held by software, and hackers seem to always be able to find ways to exploit vulnerabilities in code and make away with funds. Some coins that people are depositing for yield farming are also only a few years old at most, and could potentially lose their value, causing the entire system to crash. What’s more, early investors often hold large shares of reward tokens, and their moves to sell could have a huge impact on token prices. Lastly, regulators are yet to opine on whether reward tokens are or could become securities — decisions that could have a big impact on the coins’ use and value.