1.1.0. Four Reasons Why Yield Farming Produces Abundance
You may be wondering why yield farming often produces good return on investment. There are four main reasons:
(1). Transaction Fees
By supplying liquidity, you receive interests – transaction fees. The interests come from the transaction activities within that liquidity pool. For every transaction in the liquidity pool, you get a certain percentage of payment for supplying liquidity to the pool.
The interest rate is determined by the supply and demand of the market in the pool. When there’s a lot of liquidity in a particular pool market because there are many suppliers (depositors) or because there are a few numbers of borrowers, the interest rates will be lower.
If there is less liquidity, then the interest rates are higher to attract more suppliers to add more funds to the pool and more traders to transact with the funds.
The interest rate is calculated as Annual Percentage Rate (APR) or Annual Percentage Yield (APY) of the total amount of crypto asset you supply. Remember that for APY the interests can compound over a period while for APR, the interests do not compound. For more on the differences between APY and APR, see the modules in Class 3 of the Secondary SOC.
(2). Token Rewards
In many yield farms, when you supply your cryptos to a liquidity pool for yield farming, you receive another crypto as a reward. For instance, for providing liquidity in Pancakeswap, you can receive Pancake tokens as a reward.
The reason for this is to encourage you to leave your cryptos in the liquidity pool.
Thus, besides enjoying transaction fees, you will receive as rewards other tokens which you can supply to a liquidity pool to yield more tokens.
(3). Price Appreciation
These tokens you receive as rewards for yield farming and even the original cryptos that you have supplied for the liquidity will grow in price as the Crypto Market advances. This will provide additional profit for you.
(4). Passive Income
Note that as long as you leave your cryptos in the liquidity pool, you continuously get these three incomes – transaction fees, token rewards, and price appreciation. The combined profits can be quite lucrative, some as high as 2 000 to 7 000% APR in some cases. That is insane profit, isn’t it?
In other words, they continuously generate Passive Income for you as long as you are still farming.
Passive income generation is one of the beautiful things about DeFi and it is available for you to tap into it.
However, note that not all farms will yield the same high profits. Therefore, before you supply your cryptos for yield farming, always compare the return on investment among various farms.