How Is Yield Farming Token Used? Let’s Get the Terminology Clear

The Definition

This is an internal recording on a blockchain in the form of a smart contract or, otherwise, digital assets with value. Its purpose is determined by the goals and functions of the platform.

Not the Same as Cryptocurrency

In decentralized crypto markets, the crypt plays the role of fiat money. Yield farming is part of DeFi, but its own coins are more often used here. Each currency has its own value and purchasing power. They can be used to pay for both physical and digital objects. They represent an independent payment instrument.

Various Types of Yield Farming Work

Governance Token

This is the asset distributed among early adopters during the ICO on the crypto market. Apart from the potential value that it might bring if it becomes successful, it also provides users with rights to contribute to managing the start-up. In the case of yield farming, it might mean adding new currencies, changing the technologies, etc.

Liquidity Token as Part of Smart Contracts

It is a confirmation of the share of the contribution to the liquidity pool. At the same time, the actions of investors fall into smart contracts, which allows you to ensure yield farming is safe.

The Operation Principle of Yield Farming

Yield farming has already become an integral component of the market of decentralized finance. The idea that tokens and coins should work instead of just being stored in wallets was first brought up by the founders of the Compound protocol.

Staking

This is the traditional blockchain-based method of making a profit. Investors lock up their money in wallets for earning interest. The exchange receives funds for regulating the demand and supply. In fact, staking is an indicator of the project’s viability because by locking up their assets, users ensure the operation of the blockchain.

Additional Liquidity Incentives

The competition in the yield farming market is constantly increasing, and new players need to offer their users innovative ways of making a profit. For example, PancakeSwap organizes lotteries with a ticket cost of about $5 in Cake. Users can also test their analytical skills by trying to predict the price of BNB-USDT. Even though the rewards are usually small, it is still nice to get them.

Strategies of Yield Farmers

Investors have access to various ways to make income, from yield farming a single cryptocurrency to more complex strategies.

Simply Yield Farming

The classic way to generate income is by investing two assets in a 50/50 ratio.

Lending and Depositing

In this case, coins are not locked up in the system but rather deposited at an interest rate. It should be noted that DeFi platforms offer significantly higher interest rates which sometimes reach over 20%.

Double Lending

Some exchanges offer rewards to lenders and borrowers in their own tokens. Users can increase their profits by taking out a loan and using it for lending.

Lending and Yield Farming

Borrowing costs are often more than compensated for by staking rewards. In order to lock up a pair of coins, it is necessary to purchase them. If a user considers it to be unprofitable (for example, if there is a rise in the price of one coin and a decrease in the price of the other), it may be easier to resort to borrowing on the same platform. In this case, you will not need to spend more on buying the coins, which are more expensive at the moment.

Profitability Indicators

There are two ways to find out the potential profitability in DeFi.

Annual Percentage Rate (APR)

This indicator corresponds to earning interest over a year. The value of funds is multiplied by the interest rate to calculate the returns.

Annual Percentage Yield (APY)

The profits take into account the reinvestment of returns or the effect of compound interest. If you earn interest every month, the total amount will be bigger because every time, the annual rate is accrued on the increased token balance.

Yield Farming Work

Total Value Locked (TVL)

This indicator shows the total value of tokens and coins currently staked on the yield farming platform. The higher it is, the more yield farmers have entrusted the platform with their money.

Total Revenue

This indicator allows users to assess whether yield farming on this protocol is safe and reliable. It shows how many people are ready to pay for the platform’s services.

Protocol Revenue

It represents the share of revenue that goes to token holders. For example, let us take a look at the charts of Sushiswap (the first screenshot) and PancakeSwap (the second screenshot).

TVL and Total Revenue

The ratio of these two indicators demonstrates the efficiency of a yield farming service. The TR/TVL ratio shows the revenue for each dollar locked in the system.

Token Protocols

A protocol is a standard. Its purpose is to ensure compatibility. When it comes to tokens, a protocol is used for defining the rules to facilitate interaction in the decentralized app system.

ERC-20

Currently, the standard protocol is ERC-20. All other standards follow its guidelines and offer some modifications. Many tokens are ERC-20-compliant, which ensures compatibility and safety.

BEP-2

This is the first common protocol for all Binance tokens that operates only on the blockchain on this exchange. The next protocol, known as BEP-20, allows transferring tokens between various networks. This technology allowed the creation of tokenized versions of coins such as Bitcoin, Ether, Litecoin, etc.

NEP-5

This is an emerging protocol of the NEO network that ensures a high speed of financial transactions (a new block is generated in 15 seconds instead of 6 minutes in the case of Ethereum) and zero transaction fees while also supporting several programming languages. So far, there have been few ICOs on this blockchain because it is less known by investors, unlike Ethereum. However, the NEO token trades on exchanges, with its price varying in the range between $20 and $25 in early 2022. In May 2021, its price spiked to $122.

Conclusion

In yield farming, tokens play a very important role. They allow users to deposit coins based on various blockchains easily. They unify all operations, fees for financial transactions, and returns.

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