Basic Overview to Yield Farming
Primer to yield farming terminology and how it works in BSC
The advent of low gas fees and quick transaction times in Binance Smart Chain (“BSC”) transactions has led to an explosion of yield farming platforms in the ecosystem. As of the time of this article, 5 out of the Top 10 projects listed in Defistation.io are yield farming platforms, with the other 5 projects have their respective main products while also offering alternative solutions to make your tokens work for you.
With the massive growth in both demand and supply for yield farming, comes also an influx of new blood into the ecosystem. Even after getting set up in the DeFi space it may still be confusing to understand how money is being made for you.
We hope that this primer serves to shed some light into this oftentimes confusing space.
How does it all work?
We will not go through the mechanical aspects of this here. Instead, we discuss the token economics (“tokenomics”) of the system, and how tokens are minted, rewarded, and circulated.
Staking and Providing Liquidity
This is the backbone underlying the yield farming concept. The very first step of the yield farming lifecycle is to deposit crypto-assets into the yield farming platform. Depositing these tokens into the platform’s system grants you a share of any yield that is rewarded by the platform.
Platforms often differentiate between single token staking (“Pools”) and providing liquidity (“Farms”):
- For single token staking, simply depositing the right token into the pool will grant you a share of the yield being generated.
- For liquidity provision, you must deposit the correct liquidity pair (“LP”) token into the farm instead of the underlying tokens themselves. A LP token represents your ownership over the liquidity pool which you have provided liquidity to.
Minting, Emissions, Reward Tokens
If the farms and pools are the backbone of the yield farming platform, the reward tokens represent the lifeblood. Yield farming platforms often create, or “mint”, their own token (“native tokens”, or “reward tokens”) which they give as an additional reward to incentivize depositing assets into their platform as compared to another’s.
There are some common concepts to understand in the majority of yield farms in the BSC ecosystem, which are:
- Emissions: Typically represented as an emission per block number. This represents the number of reward tokens being minted per BSC block, which is approx. 3 seconds.
- Allocations: Typically shown as a multiplier next to the respective farms or pools, such as “40x”, “10x”, or even “0.01x”. How they work vary on each platform, but these numbers represent the portion of the emissions being allocated for each farm/pool.
- Total Value Locked (“TVL”): Represents the total assets that are being deposited in any specific farm/pool, or even in the entire platform. Often this is expressed in USD terms. Your deposits are usually shown as a % of TVL in the farm/pool.
We have been talking a while about yield generation without truly explaining it. Now that we are done reviewing some of the basic concepts, we can get to the part people are most excited about. The number of tokens that you earn in any particular farm/pool is dependent on three factors:
- Emissions per block
- x Farm/Pool’s portion of the emissions (determined by the Allocation)
- x Your share of the TVL (determined by the amount of assets you deposited divided by the total assets deposited by everyone)
Example (illustrative only): Pancake Swap emits 25 $CAKE per block. Let’s say that there is a Token_A pool which is allocated 20% of total emissions, which works out to be 5 $CAKE per block (20% x 25). Token_A pool happens to have $90,000 worth of Token_A deposited, or $90,000 TVL. You deposit $10,000 of Token_A into the pool, increasing the TVL to $100,000. Since your share of TVL is 10% ($10,000 / $100,000), you are therefore eligible to (25 x 20% x 10%) = 0.5 $CAKE per block.
APY / APR / DPR or Daily APR
For the benefit of investors, farms/pools usually sum up the data points above and represent them using three numbers. In the cryptocurrency space, these numbers only represent a snapshot at that point in time and would often be updated per block to reflect the right calculation.
- Annual Percentage Yield (“APY”): Returns assuming that reward tokens are compounded back into the farm/pool. Varies depending on compound assumptions (# times a day).
- Annual Percentage Rate (“APR”): DPR x 365.
- Daily Percentage Rate (“DPR”) or Daily APR: The rate at which you earn reward tokens over 24 hours. Other than the yield calculation above, this is estimated based on the relative value of the reward token vs. the deposited token. In other words, if the value of the reward token goes up relative to the deposited token with all else being equal, the APR goes up (and vice versa).
APY / APR / DPR are therefore an output, which is the result of taking all of the above variables and crunching them into a single understandable and comparable number. However, the caveat is that they are only accurate at that exact point in time, and should any of the above variables change they will follow likewise.
Harvesting and Vaults
Finally, in order to receive your rewards you have to harvest them. This is done by simply clicking “Harvest”, “Receive Rewards”, or any other variation that will be listed in the farm/pool. This is considered a transaction and will place the reward tokens directly into your wallet, after which you may deal with them as you please.
Vaults are essentially “smarter” versions of farms/pools which auto-compounds your deposited assets for you. They essentially sells the rewards automatically, buys your deposited token, and re-deposits it for you. Other than these extra steps, they work similarly as farms/pools.
Let’s review what we covered:
- Yield farming platforms reward native tokens to incentivize assets onboarding to their platforms
- Deposit assets whether it be single tokens or LP tokens into your chosen yield farming platform
- Earn rewards which can be estimated by the APY / APR
We hope that this primer grants you a basic understanding of how yield farming platforms work and how certain numbers and figures are expressed.
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