The precise mechanics of yield farming depend on the terms and features of the individual DeFi application. The practice started out by offering users a small share of transaction fees for contributing liquidity to a particular application, such as Uniswap or Balancer. However, the most common yield farming method is to use a DeFi application and earn the project token in return.
This practice became popular early in the summer of 2020 when Compound announced it would start issuing its COMP governance token to lenders and borrowers who use the Compound application. It was an instant hit, pushing Compound to the top of the DeFi rankings.
Since then, several projects have followed suit by creating DeFi applications with associated governance or native tokens and rewarding users with their tokens. These copycat tokens have replicated COMP’s success like, for example, Balancer’s BAL token, which gained 230% immediately after launching. The continued success of each new project fuels more innovation, as projects compete fiercely for users.
The most successful yield farmers maximize their returns by deploying more complicated investment strategies. These strategies usually involve staking tokens in a chain of protocols to generate maximum yield.
Yield farmers typically stake stablecoins, such as Dai, Tether (USDT) or USD Coin (USDC), as they offer an easy way to track profits and losses. However, it’s also possible to farm yield using cryptocurrencies such as Ether (ETH).