The birth of cryptocurrency has opened more doors for innovations, offering opportunities to earn passive income. Projects are leveraging the underlying infrastructure — blockchain technology — to help investors manage their assets and reward them with passive income. Part of the evolution witnessed in the crypto space is the birth of DeFi in 2020.

Ever since the inception of Decentralized Finance (DeFi), yield farming has gained prominence among cryptocurrency users. It became more popular after the initial launch and distribution of $COMP, the governance token of the Compound ecosystem.

Users earned rewards with the newly minted tokens via lending and borrowing activities which later resulted in the process known as “Liquidity Mining”. It is worth noting that DeFi was founded and designed to challenge the constraint of the traditional financial system called Centralized Finance (CeFi).

Yield Aggregators, being a fast-growing and burgeoning financial assets managing protocol, have recorded over 3 billion dollars worth of tokens locked up in yield aggregators around Blockchain platforms.

Yield Aggregators also known as “yield optimizers” or “yield-compounders” can also be referred to as a set of smart contract protocols that pulls together the assets of crypto investors and injects them into yield-paying services or platforms through an automated and pre-designed dispatch technique.

What Is Yield Farming?

Yield farming can be referred to as the process of investing in protocols that will yield interest. This interest is paid in tokens of the protocol where the capital is invested. The token received by investors is sold in a DEX while the remaining part of the profit gained is reinvested in the same protocol to increase the investment and return. Yield farming is one phase of DeFi that allows crypto investors to earn income by migrating their assets to a yield-generating smart contract.

Yield Aggregator and Yield Farming are two crypto concepts with common features. While yield Aggregators have to do with an auto-compounder mechanism that takes care of investors’ assets and provides outstanding DeFi crypto-staking opportunities to increase investors’ profits, they are related to the extent that yield farming is the process automated by yield Aggregators’ protocols.

There are various yield aggregators across the crypto space that share similar investment plans. The technicality about them is that they support different blockchains, charge different fees and interest rates, and the DeFi smart contract utilized by them differs and investors go for those that match their interests.

The Gate Token (GT) which is the unique exchange token of Gate.io exchange and also the native token of the Gatechain is available in some automated Yield Farming protocols and offers high-interest rates.

Features of Yield Farming

Borrowing

Sequel to the introduction of yield farming, the demand for loans on decentralized exchanges (DEx) used to be followed by interests. This is because borrowers were desperate to invest in the bullish market and earn profits in high APY. Despite the incessant increase in interest, investors still borrow funds from lenders which in return increases the portfolio of crypto lenders.

Allocation of Profits to Traders

Sometimes, tokens allocate revenue going through the protocol to users, that is, the more users trade, the more the profit of liquidity funders. For example, in sharing revenue collected, stakers of CET tokens receive it in return.

Liquidity Mining Event

At inception, some set of protocols rewarded early adopters and users for their support during the early stages of the project and testing. For example, Beefy Finance and Yearn Finance rewarded their early-stage users with governance tokens. This in turn persuaded the users to add more to the amount invested to receive more governance tokens. The governance tokens given are valuables and serve as a key to participate in the future direction of the project.

Yield Aggregator Mechanism: How Does it Work?

To participate in yield farming on any set of protocols, users have to stake (lock up) their assets to get compensated for the following five forms of values provided:

Lending to Traders

The evolution of pool value has been regarded as a major change in DeFi protocols. Immediately after the birth of DeFi protocols, crypto Lending activities have greatly expanded in the Crypto space. Before mid-2020, users could only borrow from large institutions or centralized finances. Currently, different decentralized protocols have room for various lending activities. For example, traders can lend token positions to any individual; that is, yield farmers can deposit tokens in the funding pool to maximize the number of governance tokens earned. Thus, the assets deposited can be borrowed using reasonable collateral. Meanwhile, most protocols now focused on over-collateralized lending thereby making the lenders mostly fall into collateral depreciation.

Governing Protocols

When it comes to management and governance, the governance tokens given by the protocols to investors can be used to write and review code, vote on proposals, and so on. Yield farmers earn more returns implicitly and explicitly if they efficiently manage the protocols, redirect resources towards high value-added opportunities, save the cost of transactions or use automated portfolio management.

Network Operation through Validating Transaction

This is one of the basic underlying infrastructures of every ecosystem. For an ecosystem to enhance its efficiency and performance, it needs some set of speakers called “validators” to serve as node operators. Aside from the computational incentive problem-solving Proof of Authority (PoA), other public chains rely on validators (PoA) to help secure network operation and process transactions in exchange for payment in the network’s native token. For example, Coinex Smart Chain uses 101 validators to help process transactions on its public chain. Meanwhile, each validator receives rewards in its tokens based on the amount staked. The minimum amount of CET a user can stake to become a validator is 10,000 CETs.

Providing Liquidity For Token Holders

In the past, yield farmers provided liquidity for decentralized exchanges (DEx) and professional market makers only. Currently, it has been democratized and heavily extended by DeFi protocols. Liquidity provided in the form of cryptocurrency by farmers is deposited into the liquidity pool (also called automated market makers).

Traders who need liquidity can swap tokens and Liquidity Providers (LPs) can receive a share of the transaction fee in return. However, fees earned by liquidity providers can be lost if the fundamental exchange rates change. Also, the annual staking percentage (APY) and profits rate can be affected should investors claim their dividends manually and pay gas fees for every transaction.

Both APY (compounding interest included) and APR are major pointers of earnings accumulated by investors from the deposited tokens on a DeFi platform. Good examples of major protocols running liquidity pools are Yearn Finance, Beefy Finance, Badger DAO, Autofarm, and so on. These pools enable the smooth facilitation of trade between assets pairing and serve as a centralized liquidity base.

To cap it all, yield farming is basically another form of business conducted on the blockchain. It has to do with the combination of farmers’ investments to provide profits using different strategies while remaining fixed and waiting to accrue earnings through auto-optimization. This gives room for users to unstake their investments, take out their profits and reinvest. The reward given in return can be used to influence the direction of the project in the future through voting. The tokens that are given as compensation are called “governance tokens.”

The governance tokens by the protocols can be used to propose, incentivize the network activities, and vote on changes that might take effect on the project.

Are there Risks Associated with DeFi Yield Aggregators?

Yield farming is not a risk-free business that investors can venture into as there are an increasing number of “scam projects” promising huge yields in a short term. Therefore, prospective yield farmers should be knowledgeable of the risks associated with yield farming and only invest what they are willing to lose.

Moreso, yield farming is all about investing crypto tokens in a set of protocols with rewards in return. That is, instead of the investors withdrawing or selling their assets, they stake them in a DeFi yield aggregator to increase their token holdings.

As beautiful as this strategy may look, it has potential risks. A close comparison is the traditional farmers that use their money (portfolio) to buy crops and plant, with the hope to generate income (yield) by the end of the season. The possibility for rewards and losses derived from farming will be determined by the project owners, protocol layers, and system composability. It is recommended that investors should only deposit the amount they are willing to lose because of unforeseen impermanent losses and liquidation risks attached to yield farming.

Farmers may face imminent liquidation when the value of collateral deposited by an investor that took a loan falls below the liquidity boundary and could lose their funds in the event of a cybersecurity breach. To avoid the duos, users should ensure enough research is conducted about the platform before depositing funds. Also, users should be alert, monitor the performance of the DeFi protocol from time to time, and shouldn’t rely on a single pool for investment. Moreover, they should learn to take profits when necessary, migrate their assets from one pool to another for profit maximization, and most importantly, invest the amount they can bear to lose as the crypto industry is at its nascent stage and highly volatile.

It is worth noting that, while scam yield aggregators are promising huge yields, there are reliable yield aggregator protocols that manage investment, reduce costs, and optimize the harvest circle. Yield Aggregators such as Yearn Finance, Harvest Finance, Trader Joe, DeFi Yield Protocol, Beefy Finance, Badger DAO, Idle Finance, and Pickle Finance, among others, are secure for users’ investment.

Examples of Yield Aggregators

Yearn Finance

One of the first-generation yield aggregating protocols is Yearn Finance, launched on July 17, 2020. Apart from being the biggest yield aggregator in the crypto space, it offers multiple products and integrates other chains for more opportunities, featuring products where investors can deposit tokens to receive rewards (yield) after some time. It also makes provision for swapping (Zap) at deposit and uses $YFI as its utility token.

Idle Finance

Launched in August 2019, Idle Finance is one of the first aggregating protocols to employ a simple lending strategy and allocates pool funds over PLFs. Powered by Ethereum Blockchain technology, Idle Finance manages treasures and businesses adopting optimization best interest strategy. This strategy allows users to strategically optimize their investment returns across lending DeFi protocols.

Beefy Finance

Beefy Finance is the first multi-chain and decentralized yield optimizer to operate on BNB Chain. Going live on October 8, 2020, it allows its users to earn “compound interest” on their token holdings. Except for the Ethereum Blockchain, Beefy Finance has expanded to other Blockchains. While it uses $BIFI as its native token; Beefy has up to 646 vaults as its main products.

Conclusion

After the initial launching of the first yield aggregator protocols, several others have come into effect. Although these Yield Aggregators share similar features and have similar targets, they are built on different Blockchain layers.

To date, their DeFi yield remains catchy and profitable. Despite its conceptual framework, yield farming remains a risky business that requires proper research and audit. With the rapid growth of innovations in the crypto space, it is expected that many of the problems attached to yield farming will be reduced.