Profitable farming
Profitable farming is a way to earn cryptocurrency with the help of an existing one.
You lend your funds to other users through smart contracts. For the provision of services, you receive a profit in cryptocurrency.
Farmers can use complex strategies. To maximize profits, they move cryptocurrency between different lending platforms.
Most likely, farmers keep non-obvious profitable strategies secret: the more people know about the strategy, the less effective it will work, and here farmers compete for the best "harvest".
Profitable farming works with users called liquidity providers (LP), which contribute funds to liquidity pools.
What is a liquidity pool?
The liquidity pool is a smart contract on which the funds are located. In exchange for providing liquidity to the pool, liquidity providers receive a reward. It can be paid at the expense of commissions generated by the main DeFi platform or some other source.
Some liquidity pools pay rewards with multiple tokens. They can be deposited into other liquidity pools in order to receive rewards already in them.
A lot of complex strategies have emerged in a very short time, but the basic idea is that a liquidity provider places funds in a liquidity pool and gets rewarded for it.
Profitable farming is usually carried out through ERC-20 tokens on the Ethereum blockchain, however blockchain bridges and similar technologies may allow DeFi applications to become independent of blockchains in the future. This means that they will be able to work on other blockchains that support smart contracts, including the DecimalChain blockchain.
Profitability of farming
Usually, the estimated profitability of farming is calculated on an annualized basis. This is an approximate estimate of the profit that you can get for the year.
Metrics such as Annual Percentage Rate (APR) and Annual Percentage Yield (APY) are often used. The difference between them is that when calculating APR, the addition effect is not taken into account, but in APY it is taken into account. Addition in this case means direct reinvestment of profits to get even more.
Remember that these are only approximate estimates and forecasts. Even in the short term, the size of the reward is quite difficult to accurately estimate.
Profitable farming is a highly competitive and rapidly developing market, where rewards fluctuate very often. If a certain strategy of profitable farming works for some time, then many farmers start using it, thereby reducing the possibility of obtaining high earnings. Since APR and APY are inherited from traditional markets, the DeFi industry may need its own metrics to calculate profits.
Risks of profitable farming
The most profitable profitable farming strategies are complex and suitable only for advanced users. One of the obvious risks in the field of profitable farming is smart contracts. Many protocols are created and developed by small teams with a limited budget — this increases the risk of bugs in the smart contract.
Even in larger protocols in which smart contracts are audited by reputable companies, vulnerabilities and bugs are constantly being discovered. Due to the inability to make changes to the blockchain, such errors can lead to the loss of user funds. This must be taken into account when blocking funds on a smart contract.
DeFi protocols are inclusive and can easily integrate with each other. This means that the entire DeFi ecosystem essentially depends on each of its components. If at least one of the components does not work properly, the entire ecosystem may suffer. This is one of the biggest risks for farmers and liquidity pools.
You need to trust not only the protocol to which the funds are transferred, but also the components on which it depends.