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Token farming and yielding are the most popular opportunities for generating yields in the global DeFi marketspace.
DeFi Yield Farming has become the most popular method to earn passive income with cryptocurrency. Yield farming can be considered a risk-free investment strategy for users to put their tokens to work.
However, the rules surrounding yield farming change often and there are numerous risks involved. The rewards are generally enough to incentivize people to stake their tokens.
Yielding token farms in two steps:
For this yield farming strategy, a user needs to:
- Get liquidity pool (LP) tokens
- Deposit those LP tokens into a farm
If a user knows what LP tokens are, it is important to understand how to get them and deposit them into a farm. This article talks about the details of the yield farming strategy.
How to Yield Token Farm?
Get Liquidity Pool Tokens
It straightaway adds liquidity to a DEX. For farming, in addition to considering the APY on the various pools, the DEX offers. It will also consider which LP tokens are accepted for farming and what the APY is for the farm.
Once the user identifies a pool, they start depositing the specified crypto assets into the pool. The user will receive LP tokens, which will be deposited into the farm.
Deposit Liquidity pool tokens in a farm
Once a user has the accepted LP tokens that are accepted in a farm, they can deposit them in the farm to start earning additional rewards.
Requirements to yield a token farm of DEX
Digital Wallet
These wallets are also known as crypto wallets or Web3 wallets. It holds cryptocurrencies and other digital assets. Self-custodial wallets are considered to be the best among all the available options.
Self-custody wallets allow users to have complete control over the components of their wallets. Whereas, in a custodial wallet, a third party has complete control.
Cryptocurrency
The wallets need to contain cryptocurrency to pay for transaction fees. These fees are used to pay for actions that make changes to a blockchain. It needs to be paid in the blockchain’s native currency.
LP tokens
To yield a farm on a decentralized exchange, a user will also need certain cryptographic assets in the decentralized exchange required for token farming. These are the liquidity pool tokens that a user obtains by first depositing equal amounts of two cryptocurrencies in a specific liquidity pool on the DEX.
Decentralized Exchange Platform
It is important to use a renowned DEX site that enables several liquid markets, where a third-party security firm has audited the protocol and the farming rewards are sustainable and attractive.
Understanding Liquidity Pool Tokens
Liquidity pool tokens are an important component of decentralized exchanges. Trading on DEX is facilitated by people adding liquidity to trading pairs. Anyone is allowed to add a crypto asset trading pair to a DEX or increase the strength of an existing trading pair by providing liquidity.
It is not possible to have smooth functioning without enough liquidity on the platform, so DEX encourages users to add liquidity by giving a part of the DEX fees to liquidity providers.
Every DEX trading pair has its own pool of liquidity. These are known as pools or sometimes liquidity pools. Liquidity providers on pools earn a proportional share of 0.25% of the total volume of assets swapped with people who trade between the assets in the pool.
A dynamic APY displays the earnings for liquidity providers. When a user deposits cryptocurrencies into a liquidity pool, the smart contract mints and sends a token that is a kind of receipt.
This token is known as the liquidity pool (LP) token, also sometimes called a liquidity provider token. It is used to realize any outstanding rewards from your position and to withdraw users’ deposited crypto assets.
Understanding Farms
DEX incentivizes people to add liquidity by giving a portion of the DEX fees to liquidity providers. Farms are a method to further incentivize liquidity providers by offering additional rewards. They work in a way that liquidity providers deposit their LP tokens into a farm, which is a smart contract collection.
While those LP tokens on the farm are entitled to the holders to earn additional rewards.
Farming Rewards and their Source
Mostly, farming rewards are paid in the native token of the chosen DEX and the supply comes from the token’s outstanding supply. The operators of the DEX fix the APY for farming rewards, which LP tokens are eligible for farming rewards, and it also specifies the time frame for which the farming rewards will be available.
Some DEX have previously offered high APYs for farming, beyond 1000%. It is an attempt to attract a high amount of liquidity and attention to the DEX. These high rewards are unsustainable, as the rewards are paid in the native DEX token.
The high APYs are very likely to attract so-called liquidity providers. These are participants who sacrifice their farming reward and immediately withdraw their liquidity the moment the farming rewards are evaporated.
This reduces the liquidity of DEX and the DEX’s token without value.
Conclusion: Calculation and Distribution of Rewards
These farm token rewards are allocated to individual users based on their proportion of LP tokens deposited in the farm and the time those LP tokens are kept in the farm.
The APY is estimated using a model that depends on distribution periods. This estimation generally assumes that 100% of the liquidity providers for the given pool for which they have deposited their LP tokens are in the farm for the duration of the distribution period.
The liquidity providers who have deposited their LP tokens in the farm receive a higher APY than estimated. If the liquidity is increased during the time tokens were deposited in the pool, then the APY will be temporarily lower than estimated.
FAQs
What is the lockup period when depositing tokens at the yield farms?
It does not have a lockup period.
What is the best way to claim rewards?
In some cases, a user can withdraw LP tokens to claim rewards. And in other, LP tokens in the farm and claim rewards whenever a user wants.
Anurag is working as a fundamental writer for The Coin Republic since 2021. He likes to exercise his curious muscles and research deep into a topic. Though he covers various aspects of the crypto industry, he is quite passionate about the Web3, NFTs, Gaming, and Metaverse, and envisions them as the future of the (digital) economy. A reader & writer at heart, he calls himself an “average guitar player” and a fun footballer.
