Staking as new-age investment

The blockchain technology sector has been expanding every day with new use-cases and technological improvements. The newest trend of the sector is the decentralized world with DeFi, dApps, asset tokenization, digital investments, etc., which have been catching the interest of most crypto and blockchain enthusiasts. It has opened up many new opportunities for investors to earn a passive income and multiply their net worth. One such wealth creation and augmentation tool is yield farming, where the investor stakes or lends his crypto assets in order to generate high returns or rewards in the form of additional cryptocurrency.

Yield farming: A virtual farm to yield massive returns

The market cap of the DeFi ballooning to a significant $93 billion has also given rise to numerous sub-sectors. Thus, yield farming has seen an upswing and has created a buzz around various investors as a volatile yet high reward application of the DeFi world.

Yield farming is principally a way to lock up or stake crypto assets in smart contract-based liquidity pools, i.e., pools of tokens that provide liquidity in decentralized exchanges.

As a liquidity provider, the investor funds a liquidity pool with crypto assets they own to facilitate trading on the platform and earn passive income on their deposit. The amount paid to the liquidity providers is based on the percentage of the liquidity pool they provide. These liquidity pools are then leveraged by numerous Decentralized Exchanges (DEXs).

The return generated by staking crypto assets is calculated in terms of Annual Percentage Yield (APY). APY is the rate of return gained over the course of a year on a specific investment. The yield generated from these platforms is in the form of tokens subject to high volatility; therefore, as with all kinds of investments, investors should do their due research before entering this space.

Blockchain-based apps offer incentives for users to provide liquidity by locking up their funds in a process called staking or farming.

However, certain decentralized platforms guarantee a principal return to users for participating in their liquidity pools, despite market volatility.

Crypto Assets - The New-Age Investment

Crypto assets have been at the forefront of blockchain technology for the past couple of years. It has grown exponentially in recent times. These returns may catch the eye of numerous investors worldwide, but so does the volatility they bring in.

Yield farming finds its place here amidst viable investment options by investors around the world. Investors reap the rewards in the form of token appreciation and the APY on the amount contributed and a portion of all transaction fees. Apart from this, yield farming enables token holders to earn passive income through interest on their investments locked in the lending pool. With the promise of high returns, yield farming has caught the attention of traditional and crypto investors. DeFi growth has been a key catalyst of this sector. In November 2021, the total value locked (TVL) in DeFi had surged to an all-time high of $236 billion.

Additionally, it is highly efficient and smooth for yield farmers to move their investments as and when they like and in different liquidity pools, unlike in traditional markets where complex administrative processes surround it. This also increases their chances of earning diverse tokens and higher returns.

Modern Investments with Traditional Caveats

Yield farming does promise and provides high returns, but a yield farmer runs the risk of higher losses as well. Given the speculative nature of the cryptocurrency market, the investor has to exercise caution before investing, which is a key principle to all investments.

They run a constant risk of impermanent loss where sudden and sharp market movements can lead to irrecoverable monetary losses. With investing in DeFi assets, there is an additional liquidation risk if the collateral price drops below the loan price, which causes a loss to the lender. Between January and April 2021, investors suffered $83.4 million in DeFi fraud losses, according to CipherTrace data cited by the Journal. Hence, the focus of the investors must be on the fundamentals of the project and not the yield it generates.

Additionally, the basis of every yield farming contract lies on a smart contract that is susceptible to bugs that developers may have overlooked. These overlooked can lead to major losses for the parties involved. This risk is circumvented in the sector through regular audits of the smart contracts ensuring a direct and secure code.

A Prospect worth exploring

There may be a few risks involved in a bid to increase one’s wealth, but these risks can be avoided if the user ensures an educated approach to its investments. The space has been thriving and is a promising technology that will continue to transform the global markets and systems. Therefore, getting an early head start into the sector is imperative. 

Yield farming is still in its nascent stage. As this sector gets more robust, its architects will also come up with even more vigorous ways to optimize liquidity incentives in increasingly polished ways. Exploring the yield farming sector in the current scenario is necessary for any investor to ensure a diversified portfolio that complements and augments the wealth creation process. 

The article has been written by Tarusha Mittal, COO and Co-founder, UniFarm