DeFi yield farming, explained

The benefits of yield farming are immediately apparent — profit. Yield farmers who are early to adopt a new project can benefit from token rewards that may quickly appreciate in value. If they sell those tokens at the right time, significant gains can be made. Those gains can be reinvested in other DeFi projects to farm yet more yield.

Yield farmers generally have to put down a large value of initial capital to generate any significant profits — even hundreds of thousands of dollars can be at stake. Due to the highly volatile nature of cryptocurrencies and particularly DeFi tokens, yield farmers are exposed to a significant liquidation risk if the market suddenly drops, like it did with HotdogSwap. Furthermore, the most successful yield farming strategies are complex. Therefore, the risk is higher for those who don’t fully understand how all the underlying protocols work. 

Yield farmers also take risks on the project teams and underlying smart contract code. The potential for gains in the DeFi space attracts many developers and entrepreneurs who bootstrap projects from scratch or even copy the code of their predecessors. Even if the project team is honest, its code is often unaudited and may be subject to bugs that make it vulnerable to attackers.

There have been several examples of this risk playing out as yield farming has grown in popularity. One is bZx, which suffered a series of hacks early this year and, most recently, lost another $8 million, which were later returned, due to a single misplaced line of code.

YAM Finance was another high-profile example. The project’s YAM token went from zero to $57 million in value locked in only two days after its launch in August — then crashed when the founder admitted a major flaw in the underlying code. A subsequent audit revealed several more issues related to security and performance.

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