Definition

Yield farming aggregators essentially automate the process of staking and collecting the generated rewards on behalf of users, to optimize gas fee spending via different strategies [sometimes complex]. These strategies involve moving tokens around different platforms and maximizing yields via auto compounding.

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What are Yield Farming Aggregators?

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Yield farming, also referred to as liquidity mining, is a way to generate rewards with cryptocurrency holdings. In simple terms, it means locking up cryptocurrencies and getting rewards.

In some sense, yield farming can be paralleled with staking. However, there’s a lot of complexity going on in the background. In many cases, it works with users called liquidity providers (LP) that add funds to liquidity pools.

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What is a liquidity pool? It’s basically a smart contract that contains funds. In return for providing liquidity to the pool, LPs get a reward. That reward may come from fees generated by the underlying DeFi platform, or some other source.

 

Some liquidity pools pay their rewards in multiple tokens. Those reward tokens then may be deposited to other liquidity pools to earn rewards there, and so on. You can already see how incredibly complex strategies can emerge quite quickly. But the basic idea is that a liquidity provider deposits funds into a liquidity pool and earns rewards in return.

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Yield farming is typically done using ERC-20 tokens on Ethereum, and the rewards are usually also a type of ERC-20 token. This, however, may change in the future. Why? For now, much of this activity is happening in the Ethereum ecosystem. 
 

However, cross-chain bridges and other similar advancements may allow DeFi applications to become blockchain-agnostic in the future. This means that they could run on other blockchains that also support smart contract capabilities.

Yield farmers will typically move their funds around quite a lot between different protocols in search of high yields. As a result, DeFi platforms may also provide other economic incentives to attract more capital to their platform. Just like on centralized exchanges, liquidity tends to attract more liquidity.

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What is Total Value Locked (TVL)?
 

So, what’s a good way to measure the overall health of the DeFi yield farming scene? Total Value Locked (TVL). It measures how much crypto is locked in DeFi lending and other types of money marketplaces.  In some sense, TVL is the aggregate liquidity in liquidity pools. It’s a useful index to measure the health of the DeFi and yield farming market as a whole. It’s also an effective metric to compare the “market share” of different DeFi protocols.

There are plenty of places online to track TVL. You can check which platforms have the highest amount of ETH or other cryptoassets locked in DeFi. This can give you a general idea about the current state of yield farming.  Naturally, the more value is locked, the more yield farming may be going on. It’s worth noting that you can measure TVL in ETH, USD, or even BTC. Each will give you a different outlook for the state of the DeFi money markets.

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The Risks of Yield Farming
 

Yield farming isn’t simple. The most profitable yield farming strategies are highly complex and only recommended for advanced users. In addition, yield farming is generally more suited to those that have a lot of capital to deploy (i.e., whales).  Yield farming isn’t as easy as it seems, and if you don’t understand what you’re doing, you’ll likely lose money. We’ve just discussed how your collateral can be liquidated. But what other risks do you need to be aware of?  One obvious risk of yield farming is smart contracts. Due to the nature of DeFi, many protocols are built and developed by small teams with limited budgets. This can increase the risk of smart contract bugs.

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Even in the case of bigger protocols that are audited by reputable auditing firms, vulnerabilities and bugs are discovered all the time. Due to the immutable nature of blockchain, this can lead to loss of user funds. You need to take this into account when locking your funds in a smart contract.  In addition, one of the biggest advantages of DeFi is also one of its greatest risks. It’s the idea of composability. 

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As we’ve discussed before, DeFi protocols are permissionless and can seamlessly integrate with each other. This means that the entire DeFi ecosystem is heavily reliant on each of its building blocks. This is what we refer to when we say that these applications are composable – they can easily work together.  Why is this a risk? Well, if just one of the building blocks doesn’t work as intended, the whole ecosystem may suffer. This is what poses one of the greatest risks to yield farmers and liquidity pools. You not only have to trust the protocol you deposit your funds to but all the others it may be reliant upon.

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