DeFi Part 1: How to make money with Yield Farming

Crypto Trending - Part 1

During the past time, Yield Farming has been attracting lots of attention from the Crypto market. Indeed, Yield Farming is considered a wind of change to the Altcoins market that was considered “dead” during the 2018-2019 period. Moreover, Yield Farming and Defi also opened the door for a huge source of outside capital pouring into the market.

Since the beginning of the year, Defi and Yield Farming have grown tremendously. Binance are continuously listing Defi and Yield Farming projects on their platform, most notably SuShi and YFII on Sep 1, 2020. However, Defi and Yield Farming may still seem vague to many readers. In this series, we are going to help you understand the concept of DeFi, Yield Farming from basic to advanced as well as discussing Sushi and Sushi Yield Farming.

I. What is DeFi?

Defi, which stands for Decentralized Finance, is a concept that has existed since 2018, however, until 2020, it actually grows and becomes popular to many people. So, what is Decentralized Finance?

With the current financial system, all of your activities regarding money require verification from centralized authorities (e.g., banks). For example, to borrow, save money or trade stocks, it all requires KYC (Know Your Customer) and needs to be verified by intermediaries. Even with Binance, the biggest Crypto exchange, is also an intermediary or a centralized exchange.

Conversely, with Defi, all you need is an ERC20 wallet. Specifically, DeFi applications and platforms allow you to “play” with your money freely without having to go through intermediaries, and, KYC is not needed, of course. For instance, one of the big fields of DeFi is DEX (Decentralized Exchanges). With Centralized Exchange like Binance, you need KYC to deposit and withdraw money. Also, your money is deposited into the wallet of the platform and you do not have 100% control of your wallet. However, with DEX such as BinanceDEX, Uniswap, JST SWAP, Sushi, etc., you can be able to trade directly from your wallet without needing any KYC.

As mentioned, DeFi is a broad concept with three big areas that are really trending this year, namely Assets Lending, Yield/Liquidity Farming and DEX. However, this article will mainly focus on Yield/Liquidity Farming.

II. What is Yield Farming?

1. DeFi Lending and Liquidity Pool

At the beginning of the article, we talked about the ability of Yield Farming and DeFi to bring outside capital into the market. So, why does this happen?

Firstly, we have to look at the global economy. At the moment, inflation as well as interest rates on loans and savings are rising which forced big investment funds to find new investment options to deal with inflation and make profits. With DeFi Lending, depending on each exchange and pool, you can receive a much higher interest rate than that of banks (bank saving interest rate in the US is now about 0.1% per year). As a result, lots of people are willing to deposit money into DeFi.

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Secondly, with Yield Farming, in addition to the interest rate mentioned above, you also receive interest from the Liquidity Pool, which means you are earning compound interest.

Still sounds a bit confusing, right? In simple words, with DeFi Lending, intermediaries will be eliminated which allow you to lend directly between users and enjoy a higher interest rate.

So, who will pay you? The answer is the person who borrows money from the system (it is actually your money). With an amount of money available in your wallet, you can borrow money through DeFi platforms without having to worry about any complicated verification procedures.

But, if you have money, why do you need to borrow more? The answer is to trade and hold coins. For example, if you want to short ETH, you can borrow ETH and sell it at the current price, then buy it back when the price drops to pay back the loan and make a profit.

DeFi is actually a giant bank that can automatically lend, borrow or provide capitals for users without needing any institution to regulate it. However, running a bank requires a lot of money. In the financial industry, that amount of money is called “Liquidity”. With DeFi, those who provide Liquidity to the market are called “Liquidity Pools”, which simply mean a smart contract that contains money. These pools allow users to borrow, lend, or exchange tokens. In a Liquidity Pool, there are lots of Liquidity Providers. They are the ones who put money into the pool for you to borrow and receive interest in return. Receiving high or low interest from the pools will depend on the situation of the market.

2. Yield Farming and Liquidity Mining

The act of putting money into pools and receiving interest in return is called Yield Farming. However, Compound (COMP) has taken this to a new level when they introduced Liquidity Mining.

Liquidity Mining is the act of Yield Farmers providing liquidity to the pool of Compound, and they will receive COMP tokens in return.

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With Yield Farming, users will receive interest for providing liquidity to the Liquidity Pool. But with Liquidity Mining, apart from receiving interest, users will also receive COMP tokens which give them a much higher interest rate. Each day, Compound’s system will look at all the accounts to see how much they have borrowed or provided liquidity to the system, then send each of them a portion of COMP corresponding to their contributions.

III. How to make money with DeFi? What is Uniswap?

There are two easiest ways to make money with DeFi. First is Yield Farming/Liquidity Mining. As mentioned, Yield Farming/Liquidity Mining is not simple at all. In addition, it also needs a relatively large amount of capital to bring in money. Usually, Yield Farming/Liquidity Mining aims at the Whales/Funds, those with no less than $1M in capital rather than small investors. However, many small investors have promptly followed the trend and made money from DeFi by simply investing in new DeFi projects, mostly projects on Uniswap.

Many of you may have heard about Uniswap and still do not fully understand it. Uniswap is like a normal exchange with candlesticks, trading volume, etc. To participate in Uniswap, you only need to access this link and then swap between coin A and coin B. No orderbook, no pending orders needed. Uniswap is just an intermediary.

It’s simple, right? But, Uniswap has made a huge change to the entire market. Indeed, Uniswap removed traditional orderbooks such as Binance, Bitmex, etc., and replaced them with an automated model called Automated Market Making (AMM). With the combination between this model and the features of DEX, Uniswap eliminates most of the problems associated with Market Manipulation (manipulate price on exchanges). Next, Uniswap’s ANM is essentially formed on the liquidity of the Liquidity Pool. Thanks to Uniswap, Liquidity Pools are getting more popular and useful to many people (we will talk about the operating model of Uniswap and Sushi Swap in the following article). Uniswap is also a DEX, operating for the community without making any profit (Founder of Uniswap has absolutely no income from the exchange, and Uniswap does not issue coins as well). Therefore, the “decentralization” and “intermediaries'' of Uniswap are relatively high, contributing to attracting new capital into the market.

However, Uniswap has its own drawbacks. First, Uniswap has a relatively high transaction fee at 0.3% per transaction. Moreover, it only supports ERC20 tokens (operating on the Blockchain of ETH). Next, with Uniswap, Liquidity Providers can only earn the pool’s transaction fees when they are actively providing liquidity to that pool. Once they have fully withdrawn their contributed liquidity, they will no longer receive that passive income. Furthermore, as Protocol gains more popularity, Uniswap’s profits will highly likely be diluted since investors (with bigger capability) such as ventures, exchanges are joining Protocol with a huge amount of capital.

At the end of August 2020, a “Fork” version of Uniswap was announced which solved the problems that Uniswap was encountering, as well as brought Uniswap and DeFi game to a new level: Sushi Swap.