Yield Farming is a way to put your assets to work earning additional tokens or fees in various decentralized finance (DeFi) protocols. Note that:
Yield farming can offer high returns but comes with significant risks.
Yield returns could be fixed or dynamic and can be earned on a range of assets including stablecoins.
Typically, a DeFi protocol rewards their users with their own-issued governance tokens for participating and growing their DeFi protocol.
Yield farming strategies may include:
Staking LP Tokens: Getting liquidity pool tokens from an Automated Market Maker (AMM) and depositing them in a staking program to earn more token rewards.
Lending/Borrowing: Lending or borrowing tokens and getting compensated with interest and/or governance tokens.
Leveraging:Depositing tokens in a smart contract and using them as collateral to borrow additional tokens. Some users then take these borrowed funds and lend them out again thereby "leveraging" their assets.
Combination of other strategies: Users can combine all of the above strategies by, for example, leveraging an asset and putting borrowed tokens in a liquidity pool or staking program.
All yield farming strategies comes with various risks explored below.
Yield farming risks include:
Smart Contract Bugs:A poorly-tested/audited protocol could face various bugs and issues that could lead to permanent loss of user funds.
Hack Attempts:Virtually all DeFi protocols are a target for hackers who aim to uncover attack vectors that enable them to drain funds from a protocol.
Systematic Risks:In volatile markets, rapidly changing asset prices could lead to liquidation of your collateral, network congestion that causes protocols to behave in unexpected ways or significant impermanent loss in liquidity pools.
It is advisable that a user first understands the risks involved with a protocol before participating.
It's always better to try a new yield farm with small/test amounts first.