In 2022, the correction affected all areas of the digital market. Despite the decline in performance, the DeFi sector is not losing popularity. One of the drivers of decentralized finance is profitable farming. Investments in liquidity pools and lending platforms bring high returns – up to 4000% per year. Risk is limited by coin novelty and volatility. In 2018-2020 such platforms worked on the Ethereum blockchain, so they were only available to investors with large capital. In 2022, cryptocurrency farming will be a tool for the masses. Many DeFi services operate on networks with low fees. Investors can place $10 in liquidity pools, staking, or lending platforms.
Table of Contents
What is cryptocurrency farming?
For the first time, the Compound decentralized exchange implemented this way of earning in 2020. For a fee, clients were offered to invest in liquidity pools and issue loans on landing platforms. Profits were accrued in native COMP tokens.
The first DeFi worked on the Ethereum network. In 2021, cheaper blockchains will appear (Cosmos, Polygon). In 2022, 62% of decentralized finance services will be deployed in the Ethereum ecosystem.
An algorithm based on supply and demand sets liquidity providers’ interest. The amount of the reward may change depending on the market situation.
The volume of Locked Assets in DeFi Protocols in 2020-2022
How farming works
Profitable farming involves locking coins in liquidity pools to generate high income. The protocols incentivize investors with attractive cryptocurrency rates and transaction fees. The cumulative profit is expressed as an annual percentage of APR.
To earn money in cryptocurrency farming, you need:
Select a service and connect a wallet.
Deposit 2 coins in equal shares (price ratio). In return, the algorithm will credit LP tokens. The nominal value corresponds to the user’s share in the pool.
Profit is accrued every day. To withdraw it, you need to pay a network commission. Income can also be reinvested. To withdraw funds, you need to unlock LP tokens. This takes from a few minutes to two weeks. Free tokens can be exchanged for initial assets.
As the price of one coin rises, its share relative to another decrease. Therefore, the investor will receive assets in different proportions, but the total cost will remain the same. High-interest rates offset potential losses. As additional incentives, protocols can offer new coins that are not yet traded on exchanges.
The role of the liquidity pool
Early DeFi applications experienced high slippage. Due to low liquidity, the exchange took a long time. Centralized exchanges (CEXs) do not have this problem. Clients place orders manually. Service employees analyze the order book. If there is not enough liquidity, the exchange attracts market makers. Professional bidders ensure the execution of orders at their own expense at favorable prices. For this, CEX pays high commissions to market makers.
For a quick exchange without intermediaries, liquidity pools are used on the DEX – storage of pairs of tokens. Any participant can become a cryptocurrency provider and receive a high income. An intelligent contract performs the instant conversion and adjusts the rate (automatic market making). DEX users can quickly and anonymously exchange assets with minimal slippage. Liquidity providers are highly rewarded based on the funds deposited.
Decentralized finance offers an alternative to the current banking system. The young market needs liquidity, so protocols are taking steps to incentivize providers. Services pay high interest in native tokens, add additional rewards in new cryptocurrencies, and issue lottery tickets. To make money on liquidity mining, you need:
Select a project.
Block assets in liquidity pools or on landing (lending) platforms.
Investors receive from the project a percentage for the use of assets and transaction fees. In July 2022, the AAVE service offers to deposit stablecoins with a yield of up to 2% per year and coins – of up to 35%. Vaults of cryptocurrency pairs accept assets at 60-100%.
A popular direction in DeFi is the issuance and receipt of secured loans in cryptocurrency. In July 2022, AAVE enters the top of the best lending platforms. In 2020, the protocol only worked on the Ethereum ecosystem. In 2022, users can switch networks between Polygon, Fantom, Optimism, Harmony, Avalanche, and Arbitron. The scheme of work is as follows:
On the project site, select the network (at the top of the screen).
Connect a blockchain-enabled wallet.
In the Deposit tab, select an asset taking into account interest rates.
Agree to the option to use the deposit as collateral if the participant wants to take out a loan later.
Confirm the transaction in the wallet.
The service will automatically place the assets on the landing page. In return, the investor will receive a token (for example, aDai, aUSDT). The number of derivative tokens is growing, considering changes in interest rates. AToken can be stored in a wallet or used in other DeFi projects to generate additional income.
How much can you earn
Cryptocurrencies use an annual percentage rate (APR) in farming to bring projects to a single format. The indicator is floating; it changes every block, considering the volume of the pool, supply, and demand.
Experienced farmers are constantly looking for new offers with more favorable conditions. When calculating profitability, the following parameters should be taken into account:
Cryptocurrency prices. If rates fall 50-70%, an income of 50-300% per annum will not be able to compensate for the losses.
Reward currency. Most services pay with native tokens. Such assets are often issued with unlimited issuance. In the long term, the coins are prone to fall without additional measures from the developers. In dollar terms, the investor will receive less.
Irregular losses. Placing volatile assets in a pool is less profitable than simply holding them. High-interest rates compensate for possible losses. You must leave the trade at the entry price to avoid losing. The safest option is a pool of stablecoins (yield up to 15% per annum).
The best cryptocurrencies for farming
Income farming comes with the risk of intermittent losses:
The investor deposits 2 coins in the exact dollar equivalent.
In return, the algorithm allocates Lp tokens in proportion to the share in the total pool.
If the rates of cryptocurrencies rise or fall, the number of locked coins changes.
Upon exiting the project, the investor will receive the same share in the pool, but it may be lower in dollar terms.
It will be possible to calculate non-permanent losses in the online calculator. To do this, you must specify the amount of investment and the initial and final prices of tokens. The table contains the average exchange rate fluctuations and their corresponding losses.
CHANGING THE PRICES OF TOKENS RELATIVE TO EACH OTHER
The risk of intermittent losses can be reduced by investing in such assets:
Stablecoins. Backed coins fluctuate slightly relative to each other, but the yield from such farming is lower. Popular pairs are USDT/USDC and DAI/USDC.
Coins with solid correlation. Some assets fall and rise synchronously. A strong correlation is characteristic of network control tokens and native cryptocurrencies of the large DEXs associated with them (ATOM/OSMO, BNB/CAKE).
Such pairs usually have the highest volumes and average returns (up to 15% for stablecoins, up to 50% for other altcoins). The highest ATR is provided by pools in which new coins are associated with a stablecoin ( USDT, DAI) or a native DEX token (BNB, OSMO, CAKE). In such storage, you can get 200-4000% per annum. But high yields do not last long. An individual investor’s profit decreases with an increase in the pool volume.
How to start farming
Any user can become a liquidity provider. To earn money in DeFi projects, you do not need to register and verify your identity. To farm cryptocurrency, you need:
Create a wallet with support for the selected blockchain. For DeFi on Ethereum, Binance Smart Chain, and Polygon networks, MetaMask is suitable.
Top up your wallet balance. You can transfer tokens from an exchange or other storage. Fiat is not supported.
Synchronize storage with the platform.
Select pool. Deposit coins.
It is enough to control the change in rates in pools and reinvest profits 2-3 times a month. Cryptocurrency transactions are associated with high risk, so it is recommended to withdraw income regularly. Earnings on farming coins are not guaranteed; the investor may receive a loss from a strong fall in the exchange rate and slippage.
The Best Farming Platforms
Decentralized finance services aim to simplify the trading of assets and the supply of liquidity. Like in a regular bank, in DeFi projects, you can make money by placing a deposit or taking a loan. Decentralized protocols have the following features:
There is no regulatory body.
You don’t need to verify your identity.
They offer high returns on deposits.
In July 2022, the service leads in terms of transaction volume among DEXs. The Uniswap exchange was established in 2018. The founder of the project, Hayden Adams, developed the concept of automatic market making, which is used by protocols in liquidity pools.
Uniswap operates in the Ethereum ecosystem. In May 2021, the developers released the platform version v3. Total liquidity has become a vital feature of the update: the algorithm distributes assets not evenly but where they are needed. This method increases the turnover of tokens; hence the income of farmers increases.
The popular app runs on the Binance Smart Chain (BSC). PancakeSwap customers can receive liquidity supply and exchange tokens with low fees.
The developers have connected a reward in lottery tickets and NFT trading as additional incentives. You can also buy tokens at the pre-launch stage in IFO (Initial Cryptocurrency Farming Offering) and vote on the platform’s development.
The decentralized service is focused on stablecoin trading. On Curve Finance, you can exchange secured coins at a favorable rate. The protocol works according to the rules of Ethereum. The reward for blocking assets in liquidity pools is paid in native CRV tokens.
The platform is a fork of the Uniswap exchange and runs on the same codebase. In 2021, SushiSwap ranked 8th regarding assets locked down (TVL). As of July 2022, the platform is on the 6th line in the Crypto.ru ranking with a TVL of $348.2 million.
The service is ahead of the prototype (Uniswap) in terms of the number of functions. SushiSwap supports over 16 blockchains. Users have access to:
Blocking of coins in liquidity pools.
Trading with leverage.
Landing and other ways of earning.
DEX operates on the Cosmos network. Osmosis customers can:
Earn on the supply of liquidity.
Individual pools offer additional incentives in the form of Cosmos network tokens. The blockchain was chosen due to its good scalability and low fees. Transaction fees are charged in native OSMO tokens. Many operations are carried out without commissions (withdrawal of funds, adding liquidity to the pool).
According to DefiLiama, in July 2022, 62.2% of dApps were deployed in the Ethereum ecosystem. For such projects, the MetaMask wallet is ideal. When interacting with others, you need to use compatible storage:
Osmosis. Works only with Keplr.
PancakeSwap. Supports Binance Wallet and MetaMask on the BNB network.
AAVE. Compatible with MetaMask on Polygon and Ethereum networks, TrustWallet, Ledger (for Fantom, Ethereum, Polygon). For Avalanche, it is recommended to use Infinity Wallet.
Synchronization of the wallet with the DEX platform
It is convenient to use storage as a browser extension to connect to a centralized service. Selected DEXs (PancakeSwap, Osmosis) can be operated through a mobile wallet. To synchronize with the DeFi platform, you need:
On the project website, click Connect wallet.
Select a wallet from the list. To work through mobile storage, click WalletConnect, then Mobile.
Log in to the crypto wallet. Confirm connection to DEX.
Pros and cons of farming
No identity verification required
There is a risk of error or hacking of smart contracts. For example, the Poly Network platform in 2021 reported the theft of $600 million in cryptocurrency.
Potentially high income. You can receive up to 4000% per year
The project may falter. The major service Celsius stopped withdrawing funds in June 2022.
After unlocking the assets, clients receive coins in different proportions. This may result in losses.
Experts estimate the potential of the DeFi market for many years to come. The sector creates an open and transparent alternative to the traditional banking system. This is the reason for the popularity of decentralized finance.
Every year, new projects appear on the DeFi market. Developers offer high income in liquidity farming, staking, and landing. Before starting the activity, the investor needs to calculate the risks.
Unlike banks, decentralized finance is not regulated. Therefore, users are not protected from hacker attacks or developer scams. To reduce risks, it is recommended to diversify investments between dApps.