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Yield Farming Is a Risky Adventure.
Decentralized finance is now the hottest topic in the crypto market. Defi projects are the new hope for the investors to make a considerable lot of money. Yield farming is no exception. Yield farming has been growing since the previous year, and people have made huge returns through it. Is yield farming actually that fascinating as it seems? Let’s explore.
Yield farming is a practice of lending digital assets to generate high rewards in the form of cryptocurrencies. The protocols of yield farming incentivize the liquidity providers for staking their assets in a smart contract-based liquidity pool.
People lock up their money in a protocol that promises to pay them an APY, i.e., Annual Percentage Yields. This is how investors generate value through yield farming. In simple words, the investors deposit their funds in the protocol and, in return, get tokens native to the platforms.
Here, the time during which an investor gets in also matters because the earlier he gets in, the cheaper is the price per token. Hence, when the cost of token increases, the earlier investors get more benefits than the other ones.
Why is yield farming risky?
We all want to get rich. We all want to generate as much money as possible and that too, quickly. Defi space offers us the hope to make huge returns. During the chase, what people often neglect is the risks associated with the DeFi projects. DeFi space is indeed the hottest target for significant scandals.
Explicitly talking about yield farming can be one of the most incredibly complex ways to earn rewards. Both lenders and borrowers can have considerable financial risks.
The risk might include liquidation risk, composability risk, smart contract risk and impermanent loss. Let’s understand these briefly.
Investors stake their crypto assets in the liquidity pools, which are based on smart contracts. Now, smart contracts are thought to be a secure way to process transactions. Are they actually safe? No matter how well developers try to do their projects, smart contracts can still have bugs. Hackers can exploit these to drain all the money from the project.
Yield farming is also not safe from frauds and hacks. The possibility of vulnerabilities in the smart contract protocols makes yield farming highly susceptible to cyberattacks. The reason is that there is an intense competition between protocols, which can lead to coding bugs. Secondly, to work appropriately, DeFi projects are dependent on many applications. Exploitation in any application can lead to impacting the complete ecosystem.
Defi projects provide us with huge returns, and yield farming is not an exception. Yield farming is indeed a profitable business, but keep in mind the risks involved in it.
Earning income with the correct sort of investment is not wrong, but there should be proper research before investing your hard-earned money. Any vulnerability can lead to substantial financial losses. Also, the losses are permanent because of the immutable nature of blockchain. Hence, it is advisable not to forget the risk factors associated with yield farming.