Anyone who has been paying attention to developments taking place in the crypto space has probably heard about decentralized finance and the trend of yield farming that helped it in getting more than $9 billion worth of crypto locked in. Also referred to as liquidity mining, yield farming involves people using their crypto holdings for interacting with DeFi protocols for generating rewards. With these protocols, they are either able to borrow or lend tokens. With these interactions, they can get the governance tokens of the protocols, which gives them more revenue, along with a ‘stake’ in the protocol.
This trend was initiated by the Compound, a lending protocol, which issued its COMP governance token. It didn’t take long for the rest of the protocols to also introduce their own governance tokens and distribute them in a similar way. Now there are protocols, for instance, Yearn.finance, which work like smart saving accounts and help users in finding the best yields throughout the decentralized finance space and simultaneously rewarding them with YFI tokens. After a governance token was introduced by Compound, the total value locked in the decentralized finance space surged because people began switching to farm yield. As the rewards are generated from the distributed tokens, the annual yields can actually be in excess of 1,000%.
This makes it a very attractive offer because 10-year and 12-month treasury yields are giving a return of 0.6% and 0.09%, respectively. The risks are also minimal to zero because it is possible to lend stablecoins on your selected protocol. Even if the tokens you are farming lose their value, you can still get rewards by lending funds and most of the platforms offer rewards of more than 0.67%. However, there are hidden risks that are associated with yield farming and De-Fi. Small teams having limited resources are behind most of the popular De-Fi protocols, which increases the possibility of smart contract vulnerabilities and bugs.
Even some of the well-known and audited protocols have been compromised. Furthermore, scammers are ready to take advantage of any opportunity in crypto. There have been numerous cases of outright fraudulent projects and exit scams in De-Fi. Thus, even though this space does give opportunities for making money, investors also need to be careful of the hidden dangers. When investing in De-Fi, diversification should be your goal, which means you need to have exposure to top cryptocurrencies in the space. This ensures you don’t lose everything to scams, technical issues, or unexpected market moves.
With diversification, you can get exposure to the wonders of De-Fi and not lose all of your money to human error or a bug. There is no doubt that protocols distributing tokens can give you the best returns, but using them is also extremely risky. It is a good idea to use some of your funds to farm yielding on a centralized exchange. This is more stable and secure, even if it doesn’t give the same wild rewards. Just like traditional investors, you need to diversify here as well for maximizing your profits.