What is Yield Farming

Yield farming (also called liquidity mining) is the practice of strategically deploying cryptocurrency across multiple DeFi protocols to maximise returns earning trading fees, lending interest, and protocol token rewards simultaneously. At its peak in 2020-2021, yield farming offered extraordinary APYs that attracted billions into DeFi but also created significant risks and contributed to several protocol collapses.

THE DeFi SUMMER ORIGIN

Yield farming was popularised in June 2020 when Compound Finance began distributing COMP governance tokens to users of its lending protocol proportional to their activity. Suddenly, borrowing and lending on Compound also earned COMP token rewards on top of interest, creating dramatically higher effective yields. This "liquidity mining" model was rapidly copied by dozens of protocols. Total DeFi TVL grew from under $1B to $10B in months.

HOW YIELD FARMING WORKS

A yield farmer might: Deposit USDC into Aave → earn lending APY + AAVE token rewards. Take the aUSDC receipt token → deposit into Curve Finance → earn trading fees + CRV token rewards. Take the Curve LP token → stake in Convex Finance → earn additional CVX token rewards. This "stacking" of multiple yield sources on the same capital base is the essence of yield farming strategy.

YIELD SOURCES IN DEFI

Trading fees: AMM protocols share swap fees with liquidity providers (0.01-1% of each trade).
Lending interest: Borrowers pay interest that flows to suppliers.
Protocol token emissions: New governance tokens distributed to users as an incentive to attract liquidity, often called "liquidity mining."
Staking rewards: Lock protocol tokens for additional rewards.

KEY RISKS

Impermanent loss: LPs in AMM pools lose value when prices diverge, as detailed in the Liquidity Pool entry.
Smart contract risk: Complex strategies across multiple protocols multiply smart contract attack surface.
Token inflation: Protocol token rewards lose value rapidly if emission rate exceeds demand.
Liquidation risk: Leveraged yield farming can be liquidated in a market downturn.
Regulatory risk: Yield farming income is taxable as ordinary income in India at 30% + 1% TDS.

SUSTAINABLE YIELD VS. UNSUSTAINABLE YIELD

Early yield farming offered 1000%+ APYs funded entirely by token emissions, effectively paying farmers with newly printed tokens that rapidly inflated and lost value.
Sustainable DeFi yields are generated from real economic activity: trading fee revenue, lending spread, and legitimate protocol token distributions backed by genuine usage.

Terms in addition to the Yield Farming

Blockchain

A blockchain is a subset of a distributed database. The Bitcoin inventors originally prototyped the system in 2008. This modern database is made up of separate blocks that are connected together in a chronological chain. Blockchains may be used to store a wide range of data types. It has mostly been utilized as a public ledger for bitcoin transactions to date. A peer-to-peer network comprised of independent nodes uses a consensus process to ensure the blockchain's security and legitimacy. Each node in the network keeps a public and immutable copy of the data.

2 Factor Authentication (2FA)

2 Factor Authentication is a security measure with two layers. It is used by the majority of cryptocurrency exchanges. To log in, you must provide not only a password, but also a code obtained, for example, from the Google authenticator.

Airdrop

An airdrop is a method of distributing coins. End users can typically obtain coins for free or in exchange for doing a small task, such as subscribing to a newsletter, sending a tweet, or inviting others via a personal affiliate link. Cryptocurrency airdrops — the act of depositing cryptocurrency into public crypto wallets — are utilized as a marketing, liquidity creation, and network bootstrapping technique for many different types of blockchain initiatives.

Altcoin

Altcoin - "alternative coin" - is any kind of digital currency other than Bitcoin. Since the launch of Bitcoin, the world's first digital currency, many altcoins (as well as supporting blockchains) have been created. Altcoin digital currencies share many similarities to Bitcoin, but consistently and have significant differences. There are about 20,000 altcoins, and this number is expected to grow significantly in the coming years. Altcoins often develop Bitcoin features. Ethereum, currently the most widely used blockchain, supports digital contracts and separate applications where Bitcoin does not. Altcoins are also often created to cater to the needs of different users. The Litecoin blockchain, for example, can process payments quarterly for the duration of Bitcoin.

Cold Storage

Cold storage is the way to store cryptocurrency offline. The word refers to the use of offline wallets that are not connected to the internet. Cold storage is the most secure way to keep cryptocurrencies since an offline currency becomes less likely to be hacked and stolen. Paper wallets, printed renditions of private keys, and offline hardware and software wallets are all examples of cold storage.