Yield Farming

Yield farming is hunting for the best returns across different DeFi protocols. If you haven’t read about liquidity-pools, automated-market-makers, and impermanent-loss yet, do that first — yield farming builds on all of them.

The Basic Idea

Think of it with the friend group:

You have ₹1,00,000 and three friends offer you deals:

Priya: “Lend me your money, I’ll pay 5% interest”
Aman: “Put money in my shop’s cash register, I’ll give you 8% from transaction fees”
Sneha: “Invest in my new venture, 15% returns — but it’s risky”

A yield farmer moves money to whoever offers the best deal right now, and sometimes layers strategies on top of each other to amplify returns.

The Three Layers of Yield

Layer 1: Basic Yield (Provide Liquidity)

Deposit tokens into a liquidity pool → earn trading fees.

Most pools charge 0.3% per swap. Your share depends on how much of the pool you own. If there’s $1 M in t h e p oo l an d yo u co n t r ib u t e d$ 10K, you own 1% and earn 1% of all fees.

Typical returns: 2-10% APY depending on the pool and trading volume.

Layer 2: Liquidity Mining (Bonus Tokens)

Some protocols give you extra tokens on top of trading fees just for providing liquidity. It’s like a restaurant giving you loyalty points for eating there.

Why? New protocols need liquidity to function. They basically bribe you with their own token to bring your money to their platform.

flowchart TD
    A["You provide liquidity 💰"] --> B["Earn trading fees<br/>(from swaps)"]
    A --> C["Earn bonus tokens 🎁<br/>(liquidity mining reward)"]
    B & C --> D["Total yield is higher<br/>than fees alone"]

This is how some pools advertise 30-50%+ APY. The trading fees might only be 5%, but the bonus token rewards add another 25-45%.

The catch: Those bonus tokens often lose value over time (more tokens being minted = dilution). So a 50% APY in a token that drops 80% isn’t actually a good deal.

Layer 3: Leverage (Borrow to Amplify)

This is where it gets wild. You deposit $100 a sco ll a t er a l o na l e n d in g p ro t oco l (l ik e A a v eor C o m p o u n d) . B orro w$ 80. Use that $80 a sco ll a t er a l so m e w h eree l se . B orro w$ 64 against that. Repeat.

flowchart TD
    A["Deposit $100 💰"] --> B["Borrow $80 against it"]
    B --> C["Deposit $80, borrow $64"]
    C --> D["Deposit $64, borrow $51"]
    D --> E["Total working capital: ~$295<br/>All earning yield simultaneously"]
    E --> F["⚠️ If collateral drops 10-20%,<br/>EVERYTHING gets liquidated"]

You’ve turned $100 in t o$ 295 of working capital, all earning yield. If your investments earn 10%, that’s $29.50 in s t e a d o f$ 10 — nearly 3x the return on your original $100.

The risk: If your collateral drops in value by even 10-20%, the lending protocol liquidates your position. The whole house of cards collapses. You lose everything. This is why leverage farming is sometimes called “degen” (degenerate) finance.

How Yield Farmers Actually Operate

In practice, yield farmers are constantly:

Monitoring rates across dozens of protocols
Moving funds to wherever the yield is highest
Compounding — reinvesting rewards to earn yield on yield
Managing risk — spreading across multiple pools, watching collateral ratios

Some people automate this with “yield aggregators” like Yearn Finance, which automatically moves your funds to the highest-yielding strategy.

flowchart LR
    subgraph strategies["Yield Farming Strategies"]
        S1["Simple:<br/>Provide liquidity<br/>+ earn fees"]
        S2["Medium:<br/>LP + liquidity mining<br/>+ compound rewards"]
        S3["Advanced:<br/>Leverage + LP<br/>+ mining + compounding"]
    end
    S1 -->|"More complex, more reward, more risk"| S2
    S2 -->|"More complex, more reward, more risk"| S3

Red Flags

Yield farming attracts scams. Watch out for:

APY over 100%? Where is the yield actually coming from? If you can’t answer this, don’t invest
New protocol nobody’s heard of? Could be a rug pull — creators drain the pool and disappear with everyone’s money
“Risk-free yield”? No such thing. Ever. If someone says this, run
Locked liquidity with no audit? The smart contract might have a backdoor
Token price crashing while APY stays high? You’re earning a lot of a worthless token. Check the dollar value of your returns, not just the percentage

My Take

Basic yield from providing liquidity to established pools (Uniswap, Curve, Aave) is legitimate and can be worth it. Liquidity mining can be okay if you sell the bonus tokens regularly instead of holding them.

Leverage farming? That’s gambling with extra steps. The returns look amazing until they don’t. Only play with money you can afford to lose completely.

Do your own research. Seriously.

Whizzy 💭

Explorer