Diversification is the key to success in crypto yield farming – Photo: Shutterstock
Traders who go all-in on yield farming must be prepared to do serious research and act quickly to get the best returns.
As a strategy, yield farming is not dissimilar to forex trading, where traders aim to lend currencies that offer the highest yields and borrow those with the lowest interest rates.
Yield farming often involves tokens such as USDT, DAI, and USDC, but protocols based on the Ethereum blockchain are also very popular.
DAI to US Dollars (DAI/USD)
In search of maximum annualized return, or APY, farmers typically move their cryptos from one liquidity pool or lending platform to another, often requiring flirting with riskier pools.
According to investor CryptoCookie, yield farms that enable single stakes offer a better user experience than many decentralized finance (DeFi) staking platforms.
“There are several popular swaps that offer this,” she says. “However, I’m really excited about automated yield farming and yield farming management tools like Weave or Gravity Finance’s silos.”
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Leveraged stablecoin yield farming
New platforms are constantly emerging. Earlier this month, Wonderland founder Daniele Sestagalli tweeted that he was about to usher in “a new era of leveraged stablecoin yield cultivation,” offering up to 40x leverage to allow for less available capital, such as a to earn much bigger.
The first offering (done in partnership with Yearn Finance) appears to be generating over 80% APY.
But in a recent article, Tranchess co-founder Danny Chong suggested that the risks of yield farming needed to be reduced in order to attract more interest from individual traders.
Chong said platforms typically don’t address different investment profiles, specify risk levels, or provide guidelines on where investors should allocate their capital.
One of the risk factors is a temporary loss that occurs when the price of one of the assets moves significantly relative to the other half of the pair.
Ethereum to US Dollar (ETH/USD)
Another concern is changes in lending rates caused by supply and demand when a suddenly plentiful asset causes its credit value to fall.
Platform failures are also a pervasive threat.
According to Grayson, head of business development at Weave, there are a number of characteristics investors should look for when choosing a yield farm.
Need for a “balanced portfolio”
“This includes the security of the smart contract and the reputation of the team – it gets even better when it’s a doxxed team,” he says.
“Not every farming strategy has to be degenplay. You must balance your portfolio to survive in a bear market and ride the bull market. There’s always a new trend in crypto and you need bullets to fire when you catch one.”
Grayson says that any trader who is unable to understand the market sentiment, the tokenomics and how the team will deliver them will not be able to invest and double down with confidence, while in the market there is fud (fear, uncertainty and doubt).
Weave Head of Business Development Grayson – Photo: Weave
When looking for yield farms, first look at the risk level, especially when APYs go into the triple digits. Also, decide which networks you want to deploy on – if you can’t afford Ethereum gas, choose a cheaper option like SOl or MATIC.
That is the view of Kiril Nikolov, head of business development at Nexo, who says that the minimum requirement for success is a good understanding of at least one or two Tier 1 protocols like Anchor (Terra) or Curve (Ethereum mainnet).
“From there, you need a good strategy for selling rewards and diversifying what you can do by deploying more protocols,” he says.
Short-term strategies are possible
“There are also some short-term strategies that produce great returns but are only available for a few days or weeks, and others that are best optimized by compounding rewards hourly.”
The good news for traders is that yield farms do not require a minimum level of investment, as new networks allow for cost-effective deployment at any scale, with the fiat ramp being the only challenge.
“You don’t have to own full bitcoin, you can just own 0.001 bitcoin,” says Grayson.
“However, you need to know what you are investing in. If you don’t know where to start or how to judge, find a guru or community that you trust. Anyone making a crypto investment needs to understand how a wallet works, what EVM (an Ethereum Virtual Machine) is, how transactions are read, and other key factors.
Bitcoin to USDT (BTC/USDT)
As previously mentioned, one of the most contentious issues in yield farming is the extent to which investors are provided with sufficient information about risks and proper guidance as to where exactly they should allocate their capital.
Nikolov accepts that there is so much information out there that it is almost impossible to keep up to date at all times.
“There’s also a lack of guidance around the technical risks that even professional teams might struggle with,” he says. “The best-yielding farmers learn to operate in a world of incomplete information and make the most of what they have.”
Users can usually only take what the protocol created for them, Grayson concedes.
“You need to know how the market is behaving and what the protocol will deliver in order to invest with confidence,” he adds. “A good community with transparency can help newbies make the right decision.”
For example, Weave allows experienced traders to create their own strategy and share it (and the philosophy behind it) with their followers. New users can then select the appropriate strategy based on risk appetite and historical return.
Kiril Nikolov, Head of Business Development at Nexo – Photo: Nexo
Another important consideration for yield farmers is whether success depends on trading frequently and actively monitoring their positions. Grayson believes this is the case as traders must balance gains with choppy losses.
“Some users might check multiple times a day just to decide when to sell and when to offset,” he says.
A passive approach can yield better results
“When you’re running multiple protocols at once with yield farming, it’s impossible to manage everything manually. So we also try to be a hub from which users can manage different yield farming strategies.”
However, Nikolov suggests that a less active approach can be equally, if not more, effective, noting that yield farming is a very broad term, covering everything from small-scale passive deployment to a full-time institutional operation with a team of five.
“Active monitoring is a good idea to stay ahead of potential risks, hacks, and breaches,” he concludes. “But it’s not a must. In fact, optimizations like selling rewards all too often underperform than no optimization.”
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