What is yield farming?

Moving deposits between DeFi protocols to capture the highest available rewards, usually paid in a protocol's own token.

The practice became widespread in 2020, when protocols began distributing governance tokens to anyone supplying liquidity or borrowing, and the resulting returns briefly ran into the hundreds of percent. Those rates were not interest. They were a marketing budget denominated in a token the protocol could mint at will.

The distinction that matters is between yield paid from revenue and yield paid from emissions. The first is a business. The second is a subsidy with an end date.

How it works

A protocol wanting deposits offers its own token to people who supply them. You deposit into a lending market or a liquidity pool, receive a receipt token, stake that receipt in a rewards contract, and accrue the incentive token over time. Claiming it, selling it, and redeploying the proceeds is what "farming" describes.

The advertised apy is an annualized extrapolation from a short window, computed at the incentive token's current price. Two things routinely make it unattainable. The rate falls as more capital arrives, since a fixed emission divided among more depositors pays each of them less. And the token's price falls as farmers sell what they earn, which is the predictable behavior of recipients who wanted the underlying asset rather than the reward.

Costs and risks stack on top. Transaction fees on every claim and redeployment, which can exceed the yield on small positions. impermanent loss where the deposit is a liquidity pool position. smart contract risk in every protocol touched. And the price risk of the deposited assets, which continues throughout.

Example

Illustrative. A pool advertises 150 percent annual percentage yield, paid entirely in an incentive token, and you deposit $5,000.

Over one month at that rate you accrue about $625 worth of the token at the price on the day each portion accrued. If the token falls 70 percent over the month before you sell, the realized value is closer to $190. Deduct perhaps $60 in transaction fees across deposits, claims, and swaps, and roughly $130 remains. If the paired assets in the pool diverged, impermanent loss subtracts further.

The 150 percent figure was not a lie when it was displayed. It was a rate calculated from a token price that the act of farming helped push down.

Why it matters when you buy

Farming is several steps past a first purchase and it is where a lot of newly bought coins end up, drawn by a number on a dashboard. Knowing that the number is an extrapolation priced in a falling token is what separates an informed decision from a surprise. If you want yield on an asset you hold, the yield pages show staking availability by exchange and jurisdiction, which is a different and simpler product.

Related terms

• apy: how the headline rate is calculated
• liquidity pool: where most farmed deposits sit
• impermanent loss: the cost of providing liquidity
• yield aggregator: automation of the same activity
• real yield: returns funded by revenue rather than emissions
• governance token: what the rewards are usually paid in

Questions

Why do advertised yields fall so fast?

Because a fixed emission is divided among however much capital shows up, and high rates attract capital. The rate falls mechanically as deposits arrive, before any change in the token's price.

Is yield farming the same as staking?

No. Staking secures a proof of stake network and is paid in that network's own asset from protocol issuance. Farming supplies capital to an application in exchange for incentive tokens, and the risks are entirely different.

Do transaction fees matter?

On small positions they dominate. Claiming and redeploying rewards costs a fee every time, and on an expensive network that can exceed the rewards themselves, which is one reason aggregators pool the work.