Since the summer of 2020, DeFi has been on fire.
And many investors have turned to yield farming
as a way to make even more capital with their capital.
Now, many people use terms like yield farming,
liquidity providing, and staking interchangeably,
but there are differences in what they mean
and how much money you can make.
Staking refers broadly to the rewards that you get
through the validation process of a
proof-of-stake blockchain.
Staking and yield farming are similar in the sense
that they allow investors to earn
return on their assets.
But yield farming is a bit more intense,
which means the potential for a higher return
for an educated investor.
So let's do some defining.
Staking versus Yield farming - what's the difference?
Starting with the more simple one: Staking.
All cryptocurrencies have a consensus mechanism,
which basically means they have a system
that verifies transactions on their ledger.
Those who verify transactions are
paid for their efforts in crypto.
The thing about verifying transactions
is you can't make it easy to do.
Otherwise, bad actors can come in
and attack the system.
So a good way to make it difficult to
verify transactions is by requiring
resources to do the verification.
This can be done through mining a cryptocurrency
like Bitcoin does, which needs a lot of electricity and
powerful computers to verify transactions,
or through staking your cryptocurrency.
Now, Staking allows you to verify transactions
by essentially locking up
or staking that currency with a validator.
The model basically says,
if you have money in the system,
you're unlikely to be a bad actor,
so you can be paid staking rewards
for locking up your currency and
helping to facilitate the system.
The rewards are paid in proportion
to how much of that crypto you hold.
So if you hold 100 coins,
you'll receive ten times more Staking rewards
than someone who holds 10 coins.
Staking rewards are typically around
4% to 10% annually,
but some reach as high as 100% or more.
Now, usually on the higher end, those are
temporary rewards.
Now, how do you stake your crypto?
Unfortunately, each crypto is slightly different,
but the most user-friendly way is
by going through an exchange like Exodus or Binance
who offers fairly good staking rewards.
Otherwise, you can stake directly
from your crypto wallet
to what's called a stake pool.
Now, this generally gets you the highest possible rewards.
Staking is a great option if you
plan on holding a crypto long term.
Now, Yield farming.
Yield farming takes a bit more effort
and deeper understanding of cryptocurrencies
and the risks involved.
So buckle in.
You're doing more than just
putting your held coins in a
stake pool to help facilitate transactions.
Instead, you're allowing your coins
to be used to facilitate transactions
in a decentralized exchange,
something like Uniswap or PancakeSwap.
This is called providing liquidity
in a liquidity pool,
so your coins are used by a decentralized exchange
to let other users borrow or trade cryptos
through swaps.
Now, swaps are literally
swapping one coin for another.
So swapping like Ethereum for Chainlink.
I like to think of providing liquidity
as a small business because you
lock up your crypto in these liquidity pools
and you're paid a percentage of
all the transaction fees that that pool earns.
So if you're providing 50% of
liquidity in a pool, meaning 50% of the currency in that
pool is your currency,
you get paid 50% of the rewards,
which means 50% of the fees generated
you receive, which can be a lot of money.
Now there's another layer to this comparison, and that's
called liquidity mining.
I know, stick with me here,
I promise it will all makes sense.
With liquidity mining, you're
still allowing your coins to be used in a
liquidity pool, and you're still earning a
portion of the transaction fees.
But on top of this,
you also receive additional tokens,
which you can trade on exchanges
for additional cash.
So let's do an example.
You provide liquidity for an Ethereum-LINK swap,
meaning you hold both of those cryptos
and you're locking them up with
the liquidity pool.
With regular liquidity providing, you get paid
your transaction fee rewards in Ethereum.
With liquidity mining, you get your transaction fee rewards
and additional tokens from the exchange.
Let's call it token X.
This means you can make even more money.
So a real world example here
is using a protocol like Compound Finance.
You're rewarded with COMP governance tokens
when you provide liquidity through their platform.
So like other governance tokens,
COMP also allows users
who hold that token to vote
on changes within the ecosystem,
and you can still sell those tokens for cash.
So this can be additional income
from providing liquidity.
Now that you know what yield farming is,
let's talk top strategies.
The most often used strategy
for yield farming involves using an
Automated Market Maker or an AMM.
With an AMM you're required to invest
in a trading pair.
This is the swap that I mentioned earlier,
like Ethereum and Chainlink, or whichever
two cryptocurrencies that you hold
that you could help facilitate those transactions.
Most commonly, this is a stable coin though,
like USDT or Dai,
paired with a slightly more volatile asset like Ethereum.
By doing so, you're providing
liquidity to the AMM.
You're doing that so users who would like
to trade either one of those two assets
are able to do so at a fairly stable price.
The reward you get is again a
cut of the trading fees
in proportion to how much
liquidity you're providing.
The most popular places to do this
are Uniswap, PancakeSwap,
SushiSwap, and 1inch.
In the near future, we'll have even more options
once the Cardano ecosystem
has their Dexes up and running.
Now a side note here is there are AMMs
which allow you to deposit just one kind of
crypto asset instead of the pair.
However, those are more rare,
but this does put you at less risk of impermanent loss.
More on that in a couple of minutes.
Now, some high risk tolerance investors
take this several steps further
to earn even more money.
What they do is they lend and borrow
from different dApps to receive the highest
amount in rewards possible.
This is not something that I recommend.
So basically, people will both lock up their tokens
and borrow out tokens at the same time
to increase exposure
and then use those tokens that they're borrowing
to provide liquidity elsewhere.
It's like leverage liquidity and of course,
it can get extremely risky, extremely fast.
Again, not recommended.
If you're new to this, stick to basic liquidity providing.
Of course, not financial advice.
The way I like to think of
providing liquidity is how I like to think of staking.
If you plan on holding a project long term,
then this will just earn you extra income
provided that you do your research first.
So now let's talk about how much you can
earn providing liquidity.
And luckily there are tools that can help you
calculate the returns before you ever even start.
Here we can see that on Uniswap, if you provided $1,000 in an
Ethereum-USDT pool, you can get a
56% return given current rates.
Now this is quite high returns,
and of course, that is subject to volatility
and other risks that we'll discuss in a second.
A common strategy for success
when providing liquidity is
only joining pools with a lot of trading volume.
So, popular coins.
And this is because you need trades to happen
within a pool for you to actually make money.
So if you're providing liquidity for two
rare coins, you're not going to make a whole lot of money.
And now that we know what liquidity providing is
and some strategies to make money,
we need to talk risks.
Do not skip this section.
The first risk is a Rug Pull.
When you're buying new crypto tokens
for a project that hasn't launched officially,
you run the risk that that team will
take that money and run without ever
completing the project.
And this also applies to
DeFi projects where a new liquidity pool
might promise you returns in the
1000 or even million percent range.
But then it gets shut down,
before you see any returns on your investment.
- Please shut down the system.
And the scammers, of course, run away with
deposited funds.
Now this can absolutely be
avoided by just sticking with popular
apps and doing your research beforehand.
And then you have the risk of providing liquidity
for a crypto with bad market mechanics.
And this actually happened to Mark Cuban
just a couple months ago.
He was providing liquidity for a
crypto project that included a crypto
called Titan and Iron.
Iron was an algorithmic stablecoin
tied in price to the other crypto
within the pool Titan.
And then there was some selling pressure on Titan,
and this actually caused both the cryptos to
spiral down to nearly zero almost instantly.
And everyone basically lost
all their money, including Mark Cuban.
And this happened because the stablecoin was simply
poorly designed.
Pretty crazy.
But again, a situation like this
is totally avoidable.
This swap was advertising
2 to 4 million percent annual returns.
So greediness gets you in trouble,
even if you're a billionaire.
Now, the last risk to consider is
Impermanent Loss.
This occurs when you've deposited two assets
into a double sided liquidity pool
where it's required that you deposit the same amount
of two different tokens.
Now it's necessary to do this in most cases,
because many exchanges need you to have a
a proportional amount of both tokens.
for users to borrow against the pair.
Now, what happens is as the price of
your two cryptos change,
the proportion of each coin you hold
changes automatically in the liquidity pool,
and this happens in order to keep that ratio
at 50-50 for each crypto.
Now, this can be an issue if one of the tokens that you deposit
skyrockets in price
because your position of the skyrocketing coin,
will begin to sell off to keep
that proportion at 50-50.
And here's where the problem comes in.
If a crypto in your pair,
let's say doubles in prize,
you would have actually made more money by just
holding that coin
instead of using it to provide liquidity.
Impermanent loss is kind of like
opportunity cost of providing liquidity.
Opportunity cost that you may miss out on monster gains,
but this only happens
if one coin takes off and the other doesn't,
again because of that proportion balance.
Now, I don't want to worry you too much
because there are methods to limit this issue,
and it's much less an issue now
than a couple of years ago.
On Uniswap, for example, you can choose the
trading range, and if prices go beyond that
range, so if that crypto doubles,
the pair will stop rebalancing,
meaning you won't lose all of that upside.
So in summary, providing liquidity can be a great way to
earn a bit more money on the crypto that you
plan to hold long term.
This is generally a stable way to
earn more money so long as you
aren't holding super high risk projects
and you're not letting greed get
the best of you, which I know is sometimes hard to do.
So if you feel a little bit lost in the world of crypto after watching this,
and would like a more hands on approach,
you may want to consider joining my Patreon,
which is linked in the description below.
In there you'll find additional private content,
live coaching, and a private community to
bounce ideas and ask even more questions.
I think you'd really like it.
So I'd like to thank you so much for watching
and I hope you have a profitable day.