DeFi yield farming is a high-reward technique that has garnered attention in the crypto industry and rewards crypto investors with extraordinarily high ROI. The high rate of return on investment has drawn many investors into yield farming, which is expected to rise in the following years. DeFi, which stands for “decentralized finance,” is a blockchain-based financial ecosystem. It entails investing, borrowing, and lending, as well as trading. 

What is DeFi yield farming? 

DeFi yield farming is a method of investing. Yield farming lets investors earn a return by investing in a decentralized application, or dApp. Examples include crypto wallets, DEXs, decentralized social media, and other dApps. 

Yield farmers commonly use decentralized exchanges (DEXs) to lend, borrow, or stake coins to earn interest and speculate on price volatility. Smart contracts automate financial agreements between two or more parties and promote yield farming via DeFi. 

When yield farmers lend their crypto coins to a DeFi platform, the DeFi protocol compensates them with a fixed interest rate or additional incentives. Users can adjust their output based on the strategies that produce the most yield. To ensure large rewards, users must devote time to understanding blockchain technology, DeFi protocols, and various yield-producing techniques. 

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The concept of dApp 

A decentralized app operates on a decentralized network. Backend smart contracts are used for app functionality, and the blockchain is used for data storage. They cannot be taken down because they are decentralized and are not owned by an individual or a corporation. Binding the social contract is transparent and automated, as is all blockchain technology. The cryptography backbone protects the dApp from fraud. This is a suitable method for storing, transferring, and receiving tokens. 

The yield farming tactics entail at least one of the following: lending, borrowing, giving funds to liquidate pools, and staking liquidity provider tokens. 

  • Lending: By lending tokens to DeFi platforms, farmers earn a return on the tokens they’ve locked up with the platform by receiving more money. These tokens can then be swapped or reinvested to receive rewards via liquidity mining. 
  • Borrowing: Borrowing tokens, on the other hand, permits the farmer to use them as collateral in a separate protocol. Swapping coins to various protocols and continuing this cycle yields a big profit dependent on the beginning capital. 
  • Providing coins to liquidity pools: Liquidity pools are smart contracts that accept token deposits to offer liquidity to the DeFi network. Each pool contains a pair of tokens to trade. The balance is set to 0 tokens when the pool contract is formed. As a result, the original supplier, or the first individual to contribute, determines the pool’s pricing. To eliminate the possibility of arbitrage, the value of both tokens must be identical. To prevent the same arbitrage risk, the providers that follow must invest in both tokens correspondingly. The pool’s return is supplied as a liquidity token, a tradeable asset that may be exchanged or sold. 

Farming strategies are volatile, and it is critical that the farmer adheres to the proper protocols and keeps themselves informed based on the protocol and the usefulness of the strategy. 

Steps to develop a dApp 

How can we create a DeFi software that gains traction while being financially sustainable in the long run? Suppose we pare down every DeFi app to its fundamentals. In that case, we’ll find software that operates on a specific blockchain (or across multiple chains), has its own commercial rationale smart contracts codified and interacts with off-chain data if it links with crypto wallets or provides its wallet. 

Here are some steps to keep an eye out for a while building a dApp. 

What blockchain to use? 

So, how do you pick a blockchain to build a DeFi app on? Keep the following pointers in mind while choosing a blockchain- 

  • Make sure the blockchain supports smart contracts. 
  • Check how many users the chain has, economic power, network fees, and transaction speed. Look for a good blend of low expenses and high rates. 
  • Stack of technologies- What programming languages are used to create DeFi applications, and how are the developing environments? 

Finally, the decision will be influenced by the adaptability of the existing DeFi applications on the chain. Have popular Ethereum games like Aave and UniSwap already switched to this new chain? Is there an open DeFi protocol on the blockchain and bridges to other networks? 

Finding answers to these will assist you in determining the best chain to launch a DeFi app on. 

Define tokenomics 

Tokenomics is the most critical aspect of any decentralized application. Certain forms of DeFi software, such as portfolio managers, do not necessitate the creation of a crypto token to set up a DeFi app. 

However, the most successful decentralized financial apps include new tokens and new methods for working with them, such as: 

  • staking  
  • contributing to a liquidity pool 
  • exchanging 

Furthermore, it would be best if you determined whether the token you develop will be inflationary or deflationary. How it will be divided among users, what consensus protocol it will support, whether users carrying the token will have voting rights, whether it will be a Stablecoin, and a slew of other factors. 

All of these logistics will be stored in smart contracts, which function as immutable servers on a blockchain. 

Integrate crypto wallets 

As every DeFi works with cryptocurrency, it stands to reason that consumers would want a cryptocurrency wallet. Customers are usually allowed to link their wallets that they have learned to trust. 

On the other hand, nothing precludes you from creating your crypto wallet and providing private keys (often in the form of a seed phrase) to users. 

Working with oracles 

For proper execution, a DeFi may require off-chain data. Assume we’re developing a DeFi app for travel insurance. Our smart contract will require data on canceled flights and weather to trigger transactions to consumers qualifying for insurance payments. 

This off-chain data is derived through oracles, also known as data feeds. Ideally, we’d need to rely on solutions that imitate blockchain activities by requiring independent nodes to gain consensus before sending the findings to a blockchain. 

Otherwise, a centralized oracle that may be compromised poses a severe threat to our DeFi software. 

Risks involved in DeFi yield farming 

The process’s high-risk considerations complement the grand return of yield farming. First, there is the danger of liquidation, which is an issue when the market value falls. Then there’s smart contract risk, such as contract flaws, platform updates, admin keys, and systematic hazards. Because smart contracts are essential to transactions, these risks are inevitable. 

Before beginning yield farming, it is also critical to understand the consequences of temporary loss. A transient loss of cash for a liquidity provider is referred to as an impermanent loss. The liquidity pool demonstrates this. When the pool’s balance swings, it creates room for arbitrage. This results in a temporary loss. In some circumstances, the liquidity pool program’s incentives to the provider might mitigate the impact of the loss. 

The necessity of withdrawing or keeping liquidity and a thorough grasp of the DeFi protocol are critical to the liquidity provider’s profitability. 

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