What is yield farming?

Where do the rewards come from when you put your crypto “to work”? The answer depends on the app: it could be borrowers paying, users making swaps, or the protocol itself handing out extra tokens to attract capital.

Think of a shared piggy bank that funds a service. In a liquidity pool, for example, you deposit a pair of tokens so other users can swap one for the other. Depending on the app’s rules, you get a share of the fees and possibly additional rewards. In a lending app, similarly, you supply crypto and earn interest from its use.

Everything is managed by smart contracts, meaning programs running on the blockchain. People who follow these strategies are called yield farmers. Some move funds between apps or reinvest their rewards in pursuit of higher returns. Every extra move, though, can add fees and risks.

Why it matters

Yield farming helps decentralized finance (DeFi) apps attract liquidity and lets crypto holders earn rewards for participating. It isn’t the same as staking used to secure a network, although a strategy can combine different mechanisms.

We think it’s essential to distinguish yield that comes from real use of a service from yield that relies mainly on distributing new tokens. If the reward token loses value, more tokens don’t necessarily mean a bigger profit in euros.

What to watch out for

The displayed annual yield isn’t a guarantee. APR and APY rates can change, and APY factors in compounding under specific assumptions. Transaction fees also reduce the final result.

There’s a risk of a contract bug or hack, scams and loss of funds. In liquidity pools you can face impermanent loss: your position may be worth less than if you had kept the same tokens in your wallet. The name doesn’t guarantee the difference will disappear. Strategies that use additional borrowing also add the risk of forced liquidation.