Yield farming — also called liquidity mining — is the practice of lending, staking, or providing liquidity to DeFi protocols in exchange for token rewards. It started during 'DeFi Summer' of 2020 when Compound Finance began distributing COMP tokens to users, triggering a wave of protocols incentivizing liquidity with freshly minted governance tokens.
How Yield Farming Actually Works
How Yield Farming Actually Works
Providing Liquidity to a DEX
Deposit an equal value of two tokens (e.g., ETH and USDC) into a Uniswap or Curve liquidity pool. You earn a share of trading fees whenever anyone uses the pool to swap. On top of this, many protocols also reward liquidity providers with their governance tokens.
Lending Protocols Yield
Deposit USDC on Aave and earn 4–8% APY from borrowers plus AAVE token rewards. The risk is borrower default — but Aave's overcollateralized model means all loans are backed by more than they're worth, making default technically impossible in normal market conditions.
Yield Aggregators
Protocols like Yearn Finance automatically move your capital between the highest-yielding strategies. You deposit once and the protocol continuously optimizes for maximum APY — simple yield farming for less experienced users.
The Biggest Risks in Yield Farming
The Biggest Risks in Yield Farming
- ✓Impermanent Loss: when token prices diverge, LP value can be less than just holding
- ✓Smart Contract Risk: audited protocols still get hacked ($600M+ stolen in 2022)
- ✓Reward Token Inflation: farming tokens are often sold by large farmers, crashing price
- ✓Liquidation Risk: if collateral drops below threshold, loans are auto-liquidated
- ✓Gas Costs: frequent harvesting on Ethereum mainnet can eat returns
- ✓Rug Pulls: anonymous teams draining liquidity pools overnight
Yield Farming FAQs
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