All About DeFi’s Yield Farming Compound
Depositing money into decentralized protocols in return for interest—typically in the form of protocol governance tokens or other financial incentives—is known as yield farming. Other ecosystem members can then borrow these money on margin to utilize for different trading activities, or in the event of a decentralized exchange driven by an automated market maker (AMM), they can serve as liquidity to help with trade. As a result, yield farming offers consumers both passive and active ways to spend their cash that they would not otherwise have access to.
The 2015 introduction of the Ethereum blockchain introduced a smart contract-driven ecosystem that allows users to create and engage with decentralized apps. With the growth of decentralized finance (DeFi), users were able to engage in a variety of peer-to-peer financial activities, such as lending, trading, borrowing, and novel blockchain-specific methods.
One of these novel approaches made its debut on Compound, an Ethereum-based lending and borrowing network. Users of Compound received COMP tokens as payment, giving them governance powers over protocol operations and increasing user engagement.
Compound surged to the top of the DeFi protocol in just one trading day, with approximately $500 million in staked value. Up to the end of 2021, activity resulting from Compound’s token distribution was comparatively robust, with a few notable peaks in activity.
While yield farming has revolutionized DeFi, the idea itself is not new. There are a number of ways to earn interest and incentives in conventional finance, including opening a savings account, buying a certificate of deposit (CD), or investing in dividend-paying stocks.
But each of the aforementioned techniques necessitates the involvement of a third party or middleman. Since yield farming takes place in a decentralized setting, peer-to-peer (P2P) lending and borrowing are handled automatically using smart contracts.
Yield farming is advantageous to consumers of DeFi systems as well.
Token distribution platforms enhance token circulation, contributing to increased user engagement and liquidity. Furthermore, currencies that grant governance rights support platforms in preserving more robust degrees of decentralization.
Yield farming provides consumers with options for both active speculation and passive capital appreciation, both of which might be more profitable than the interest rates offered by conventional financial products. Furthermore, since yield farming requires less capital than traditional banks do, everyone may participate in it, regardless of net worth.
Yield farming, like other trading and investing activities in DeFi, is driven by smart contracts that automate lending, borrowing, and capital exchange. The actual assets, which could have different lockup times, are placed into a smart contract address linked to a specific protocol.
Essential elements of high-yield farming
Staking, lending, and liquidity provisioning are the three main components of yield farming, despite the fact that there are several active and passive alternatives.
Staking is the process by which users of the platform buy tokens and lock them up for a predetermined amount of time in return for interest.
When platform users deposit money and make it accessible for others to borrow on margin, this is known as lending.
In order to increase capital availability and receive a cut of trading revenue, players deposit tokens into decentralized exchanges (DEXs) to provide liquidity.
