Everything evolves around liquidity. Exchanges need liquidity to offer traders tight spreads. Liquidity draws more traders to a specific exchange. As a result, it produces more trading fees for the exchange. In the case of a Decentralized Exchange (DEX), liquidity providers also benefit from these trading fees. A tight spread refers to the small difference between the buy and sell price of a specific coin.
In the case of DeFi platforms, users are spoilt for choice. There are a number of DeFi protocols that liquidity providers and traders can choose from. Various DeFi platforms have had to go the extra mile to be competitive in the fast-paced market.
One such is the Compound DeFi platform that recently introduced liquidity mining. The concept of liquidity mining is simple. Users of the platform and its protocol are rewarded with coins like Compound tokens (COMP). These coins give holders the right to vote on important changes to the platform and in essence, govern the platform. Thus far, DeFi lending has been extremely popular and profitable and has seen a surge in the marketcap of DeFi coins.
Now, Yield Farming is when you use the reward coins to earn additional income.
How does Yield Farming work?At the moment, there are two ways to profit from Yield Farming. These strategies are very popular amongst traders who understand how the DeFi platform works.
1. Profit from reward tokensThe first strategy is to profit from the platform’s reward protocol. In the case of Compound, users of the platform are rewarded with COMP tokens. Distribution of the reward coins is allocated to each market (ETH, USDC, DAI etc).
Following recent changes, the community voted that the distribution of COMP tokens to liquidity providers and borrowers, will be based on the dollar value of assets that were put in or borrowed. Previously, distribution of COMP tokens was based on the amount of interest users earned or paid. A total of 2 880 COMP tokens are distributed to users on a daily basis.
Getting back to business. In order to mitigate risk, you can borrow BAT tokens for example, from one protocol and lend it to another protocol. You simply go to DeFi Rate to compare rates on the various platforms. You can borrow BAT on Aave at 0.1% interest and lend it at 2.35% interest on NUO. Calculate potential profits on Predictions.Exchange and remember to deduct the fee for borrowing BAT tokens.
2. Profit from liquidity tokensThe second strategy is to get your hands on as many liquidity tokens as you can and invest them in a pool to earn more liquidity tokens. You can re-invest in up to three DeFi protocols if you like. The Synthetix DEX offers the following reward tokens: