Yield farming is a process that allows cryptocurrency holders to earn rewards on their crypto holdings. In order to start yield farming, an investor deposits his tokens into a liquidity pool, staking pool or lending protocol to earn interest from trading fees, token rewards and staking rewards. Typically, users are also rewarded with additional (native or non-native) tokens from the yield farming platform.
Decentralized Finance (DeFi) investors earn profit with yield farming by:
- Price increase: When the price of a token in a liquidity pool, staking pool or lending pool increases, investors gain profit on their investment.
- Trading fees: Whenever an investor swaps his tokens via a liquidity pool, he needs to pay a trading fee. This fee is divided between all liquidity providers within the liquidity pool, based on their share.
- Token rewards: To incentivize new investors to deploy their assets in pools, DeFi platforms rewards investors with additional tokens (which is usually their governance token) on top of trading fees.
