In brief
Yield mining is the practice of using one's cryptocurrency assets to generate passive income or yield. It typically involves providing liquidity to DeFi protocols, lending or staking crypto assets in exchange for rewards. Some yield "farmers" use them all at once. As with all opportunities in the cryptocurrency sector, yield mining is not without risk. Temporary losses, contract or protocol failures, and exorbitant gas fees are some of the risks that operators face.
Therefore, yield operators must do thorough research before putting their money into a yield farm. Some common ways to do so include understanding the development team, security, token type, and the timeline involved in the investment. While DYOR (the act of doing your own research) cannot completely prevent cryptocurrency losses, it can help you minimize the risk.
Introduce
In its simplest form, yield mining is the use of idle cryptocurrency to earn interest on cryptocurrency. Through smart contracts, holders can lend their cryptocurrency to others and receive rewards in return. In the decentralized finance (DeFi) ecosystem, there are several ways to generate profits from cryptocurrency, the most popular ones are:
Lend assets using a crypto lending protocol.
Stake cryptocurrency on a protocol.
Become a liquidity provider (LP) for a DeFi protocol (e.g. decentralized exchange (DEX)) and receive LP rewards (see LP tokens).
Many yield operators use one or more of the above methods to build a passive income stream. However, like other DeFi opportunities, yield mining also has its risks. Whether you intend to become a yield miner or are just interested in its mechanics, you should pay attention to learn..
Risks of Yield Mining
Temporary loss
Perhaps the most prominent risk in yield mining in DeFi is temporary loss. When cryptocurrency owners participate in yield mining, they typically lock their cryptocurrencies for a certain period of time, making those assets relatively illiquid.
Temporary losses occur when the price ratio of deposited tokens changes, after you deposit them into the liquidity pool. The larger the change, the larger the loss, regardless of the direction of the price.
While the fees from yield mining can help offset losses, this is not always the case and can pose great risks. If you want to learn more, read our in-depth article on Temporary Losses.
Hacks
Smart contracts control DeFi protocols, and a single error in the smart contract code could cause the value of a token to plummet to zero. This risk is further complicated by the fact that a hacker could can exploit bugs or security issues to manipulate the project.
Fraud risk
Someone with bad intentions and the right skill set could create a DeFi platform and turn it into a legitimate yield mining site. After all, DeFi projects are open source, transparent, and permissionless, meaning anyone can copy the underlying code and create a new project. While early adopters are often rewarded more generously, think carefully before doing so, as high rewards come with high risks.
Newly launched yield mining platforms can be more difficult to research because user reviews and information about them tends to be limited. Be especially cautious with such platforms as you may not be able to withdraw your deposited funds or claim your rewards even if you change your mind after committing to such a platform.
High gas fees
When a network becomes congested, it often results in increased gas fees. Such an unprecedented spike affects yield miners who already have less money, as gas fees can eat into their earned fees. Even if they choose to leave their assets in the pool, other risks such as temporary losses and liquidations can still affect them.
Popular ways to DYOR
Security level
Ensuring the security of yield mining and DeFi protocols is crucial in preventing malicious attacks. To reduce the risk of such attacks, it is essential to determine that a reputable source has audited the smart contract code. Look for DeFi projects that have thoroughly vetted smart contracts.
There are countless DeFi projects that started with folk tales of successful DeFi protocols like UniSwap. However, many fail due to network effects or lack of liquidity and many other reasons. Worse still, some DeFi projects are even intentionally created for fraudulent purposes. For example, a scam group could create a fork, attempt to attract liquidity to it, and then disappear with the newly acquired tokens.
It is also important to know the Total Value Locked (TVL) in the project, which is the total amount currently locked in the protocol. If the TVL seems suspiciously low, it's a sign that there's even less capital locked up in the protocol, which means the other fetus will get a lower yield.
Token
Different pools offer different opportunities for different asset classes, including stablecoins and blue-chip tokens (that is, tokens from established blockchain projects like Bitcoin and Ethereum). Protocols can also distribute their own tokens to stakers and liquidity providers.
It is important to remember that a protocol can link its tokens to its services in many ways. For example, it could use tokens as a marketing tactic to attract more users. Therefore, always be sure about the tokens you will receive from yield mining.
Timeline
New DeFi protocols often offer higher rewards to early adopters, in an effort to increase liquidity. It also acts as an incentive to be willing to take risks by investing and using a new or untested product or service.
However, while early adoption can yield greater rewards, it is also a high-risk venture — the yield mining protocol may not succeed. Thus, the money and time invested may not be refunded.
Yield miners should weigh their options carefully and consider all factors, as well as other opportunities. Due to possible token inflation and the resulting price drops, new DeFi protocols will not be sustainable to deliver high rewards over the long term, especially if they reward miners with their native tokens. Surname.
Develop team
When browsing for information, look for errors from yield mining sites – small errors can indicate a group is negligent or worse, a scam. Ideally, the website should be well designed, have no typos or broken links, and look professional. Another way to evaluate the reliability of a development team is to observe whether the team carries out regular audits by an independent, external auditor.
A development team should be well-balanced and include a healthy mix of entrepreneurs, product managers, developers, software engineers, marketing experts, and financial experts. A project that has famous advisors on its board is also a good sign.
If possible, conduct research on each member of the development team. For starters, check out their social media accounts to learn about their past achievements and activity on platforms like LinkedIn, GitHub, Reddit, TradingView, and YouTube.
How they interact on social media can reveal their skills, experience, and influence. In general, an established development team with a good reputation is less likely to commit fraud.
summary
Yield mining can be a viable passive income strategy for those with experience in effective risk management. However, due to the volatile nature of yield mining and the cryptocurrency market in general, users must be vigilant, put in the effort, and take the time to plan an effective yield mining strategy.
If you are considering yield mining, the aforementioned methods can be used as a starting point to minimize risk. Additionally, you should do further research and perform due diligence before investing in any financial opportunity.
Read more:
What is Yield Farming in Decentralized Finance (DeFi)?
The complete guide to decentralized finance (DeFi) for beginners
A beginner's guide to earning passive income with cryptocurrency
Why and how to do your own research (DYOR) when investing in cryptocurrency
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