Nansen provides a guide on the best strategies to farm yield in the crypto markets
While the specifics can vary, 'yield farming' is a term that refers to the activity of lending crypto assets to protocols, platforms, or chain validators with the intent of generating additional income on the provided capital.
Liquidity providers can engage in yield farming with collateral in the form of native protocol tokens, stablecoins, application tokens, trading and lending positions (themselves represented as tokens), NFTs, and effectively any type of digital asset on a blockchain. The variety of options makes yield farming a large and complex corner of the DeFi universe with multiple subsectors in its own right.
In its most simplified form, yield farming is no more different than any other financial incentivization mechanism readily present in TradFi (i.e. lending assets for a passive return). The caveat is that the interoperability of DeFi applications gives birth to an unusually wide array of opportunities waiting to be unearthed by investors, and that factors such as smart contract risk and fund custody present different risk profiles for yield farmers. However, for users who are willing to dive into this exciting field of decentralized finance, there's an abundance of opportunities investors can choose from to bring productivity to their idle assets.
Let's take a look at key concepts and principles beginners need to know to get started making passive income with their crypto assets!
Both liquidity providers and platforms offering rewards have their own motivations when it comes to yield farming. Investors enjoy the additional income on their crypto holdings while networks and applications leverage user liquidity for their unique purposes, such as ensuring network security with the funds or accessing capital for lending, trading, and creating network effects for their services. Refer to this article by Jump Trading, one of the leading institutional participants in DeFi, in which they extensively explore the incentives allocated to yield farming.
Every investment strategy mentioned here essentially operates as a passive income strategy. However, given how quickly things can change in the yield farming world, hunting for the most profitable strategies can often feel like a full-time job, or active income generation. Indeed, there are professional yield farmers who pursue complex strategies to obtain the highest yields. Thus we can consolidate the approach to yield farming under two arbitrary categories: effortful and effortless.
In fairness, the effort input is more of a spectrum than two rigid categories but let’s use these two for the sake of simplicity. The effortless approach is settling with on-chain opportunities similar to those mostly present in traditional finance: slow-paced yield farming with a relatively stable, steady, and secure income inflow and without the need for a constant search for better yields. Staking at the protocol level for network security, lending and LPing with stablecoins or high marketcap cryptocurrencies, following some time-tested strategies, and farming on centralized exchanges constitute these opportunities that don’t require investors to stomach high risk or try to come up with elaborate strategies or catch fringe opportunities.
Effortful yield farming, on the other hand, is fast-paced, risk-on, and usually involves a mercenary approach to capital. It requires finesse in managing funds and a certain level of sophistication to navigate both the market and technology-related risks. Activities born through this approach offer lucrative results but demand a higher effort input and risk tolerance from the investor in return. Yield farming with high-risk assets like governance tokens and NFTs, searching for pool 2s, and combining numerous services to further financialize assets are some examples of high-effort farming.
Those who want to become yield farmers must know the differences between the two approaches and pursue strategies that fit their investment goals and risk appetite. Since it’s bear, investors willing to optimize for protection against volatility and minimize application-specific risks can refer to our article laying out the best stablecoin strategies for surviving the bear.
Below is a bird’s-eye view of the yield farming space, exploring some of the popular strategies investors can follow. Please note that some of these strategies may become obsolete with applications deprecating incentives.
If investors are holding native tokens for chains with inflationary tokenomics, staking may be crucial for protecting themselves against dilution and earning rewards on top. Staking is a relatively more secure way to utilize L1 tokens compared to lending and providing liquidity. One of the leading thought leaders in the industry, Arthur Hayes, goes as far as to call the staked Ether a commodity-linked bond. Here are some of the vanilla staking strategies.
To learn more about ETH staking specifically, check out Nansen's guide!
Investors can lend stablecoins, majors (i.e. ETH and BTC), and alt native tokens (e.g. SOL and AVAX) on decentralized money markets like Aave and Compound, or alternatively, use platforms like Maple Finance and Goldfinch to lend to vetted businesses. There are many lending markets optimizing for different ranges of assets and offering countless on-chain opportunities. However, the more an investor strays further from battle-tested applications the more they need to pay attention to risks.
Apart from choosing less popular platforms, another risk-on strategy with decentralized money markets is lending volatile application tokens (e.g. MANA and BAT) If an investor plans to hold a token with the anticipation of an increase in price, it might be better to have these assets work for them rather than keeping them in their wallet doing nothing and probably getting diluted with token emissions or unlocks.
Investors can lend their assets to decentralized exchanges, increase the capital efficiency of the platforms, and get a portion of the trading revenues generated on their assets. Although liquidity provision is a vast land with a risk spectrum ranging from one of the safest heavens in DeFi (stablecoin pools) to the most degen opportunities on the market, it also hosts strategies with the most financial upside potential. Here are some of the examples readers can choose from:
Certain DeFi services provide automated fund management to investors with predetermined strategies executed through smart contracts. Here are some of the examples:
Although it is a rather nascent industry, NFT-Fi offers investors several tools to get some passive returns on their assets.
Apart from these examples, the next level of yield farming is the constant search for niche opportunities, discovering wild pool 2s, and extracting as much value from the composability of DeFi. Meaningfully farming with these activities is usually more suited for knowledgeable investors with relatively small capital sizes since both the risks entailed by the activities and the size of the funds narrow down the target segment who can join.
Similar to the Curve and stETH strategies mentioned above, users can create elaborate yield farming combinations and boost their earnings. The following one from @lemiscate is a good example for these strategies.
Possibilities are limited to investors’ risk appetite. Put interest-bearing tokens to do leveraged yield farming on platforms like Alchemix and Apricot Finance, bridge your BTC through WBTC and combine Badger, Curve, and Convex for maximum results, or introduce an additional step to the Curve-Convex yield farming strategy with ButterflyDAO. Or opt in for a relatively safer option and seek profitability through complexity on stablecoins like this.
Most of the risks mentioned in our complete guide to DeFi article hold for yield farming activities, with the most emphasis should be put on the smart contract risk, the risks coming from exposure to highly volatile assets, rugpulls and scams, and the risk of impermanent loss.
Using majors instead of stablecoins introduces the risk of volatility. Meanwhile, using app tokens or the tokens for alt L1s amplify the risk of volatility as they are relatively less liquid and have concentrated ownership. Yield farming on less popular platforms with questionable auditing practices comes both with the risk of scams and exploits. On top of that, the more entrenched is an investor in a yield farming strategy, the more careful they need to be to outsmart the threats as the application-specific risks are cumulated by combining different DeFi services.
Nansen sheds light on how the maestros of the craft orchestrate their yield farming strategies and therefore is an effective tool for building and tracking strategies. Simply heading to the Smart Money section and filtering it for “Smarter LP” allows users to see the contracts most profitable liquidity providers recently interacted with, which reveals the most popular pools and the newest opportunities they discovered.
Users unleash Nansen to its fullest to level up their yield farming game. Here Nel explains how using Nansen’s Hot Contracts feature allows finding patterns in smart money activity, entering positions before the market, and exiting just before the bell tolls for the pool. Also, here Nel again, specifically talking about avoiding risks in liquidity pools.
Alternatively, Nansen’s DeFi paradise allows users to rank the liquidity pools by the number of smart money holders to see the most preferred pools by the profitable wallets or rank by the smart money ownership to see the fresh opportunities discovered by these wallets.
Like investing, trading, or any activity that can be placed on a scale of risk tolerance, yield farming is also can be simple or complicated depending on investors’ approach. Subscribe to Nansen’s newsletter to learn more about the latest opportunities and keep yourself up-to-date with farming strategies.