What is yield farming
Yield farming is a crypto currency investing method that promises higher returns than most traditional investments currently give. It might be an opportunity for the brave to strike it rich – or for holders of new currencies to influence pricing. The Securities and Exchange Commission of the United States has warned the sector that it has doubts, particularly about whether the activity should be regulated as a securities offering.
When you deposit money in a bank, you are basically making a loan for which you receive interest. Yield farming, also known as yield or liquidity harvesting, entails leasing crypto currency. In exchange, you get interest and occasionally fees, although they’re less significant than the practice of augmenting interest with gifts of units of a new crypto currency. The true benefit comes if that currency appreciates fast. It’s like if banks were attracting new depositors with the promise of a tulip during the Dutch tulip mania, or a toaster, if toasters were the subject of frenzied speculation and price volatility.
So, how exactly does it work?
First, do you know what a dapp is? That’s abbreviation for a decentralized app. Ethereum co-founder Vitalik Buterin uses the following analogy to describe the concept: if Bitcoin is a pocket calculator, platforms with dapps are cellphones, but ones on which automated applications run without the need for a central operating system or server. Many of them rely on the Ethereum blockchain, which is a digital ledger. The simplest technique is to lend digital currency like DAI or Tether through a dapp like Compound, which then loans the coins to borrowers, many of whom use them for speculating. Interest rates change according to demand, but for each day you participate in the Compound service, you receive additional Comp coins as well as interest and other expenses. If the Comp token grows in value your profits will skyrocket as well.
What are the risks?
One example is theft, which is unrelated to regulatory crackdowns. The digital money you give out is effectively kept by software, and hackers always appear to be able to find methods to attack code weaknesses and steal it. Some of the coins that individuals are depositing for yield farming are only a few years old at most, and their value might potentially depreciate, leading the entire system to fail. Furthermore, early investors frequently own substantial shares of reward tokens, and their decisions to sell might have a significant influence on token pricing. Finally, authorities have yet to decide whether incentive tokens are or may become securities, which could have a significant influence on the currencies’ use and value.
What else could go wrong?
Many high-yield harvesting systems are also vulnerable to liquidation. Many users are using complicated tactics in order to maximize returns. Some investors, for example, have deposited DAI tokens into Compound, then borrowed DAI using the initial tokens as security, and then lent out the borrowed monies. The goal is to obtain a larger share of the available rewards: Comp tokens. A shift in the wrong direction in the value of a token might wipe out any profits and force liquidations.
What about market manipulation?
When someone lends a crypto currency through a De-Fi service like Compound and then borrows it again, they create false demand for the coins, increasing their prices. This has generated fears that early adopters with big holdings, known as whales, are influencing price fluctuations, a frequent complaint in a variety of crypto marketplaces. According to crypto research firm Messari, yield harvesting “has become a game for whales who are grabbing the vast bulk of payouts.”
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