Yield Farming

Overview

Yield farming, also known as liquidity mining, is a DeFi practice where users provide liquidity or lend assets to protocols in exchange for rewards, typically paid in additional protocol tokens. Beyond the trading fees or interest earned on the principal, farmers earn incentive tokens designed to attract liquidity. Yield farming is one of the main ways users generate passive returns in decentralized finance.

How It Works

A user deposits assets into a protocol, such as a liquidity pool or lending market, and receives position tokens in return. The protocol then distributes extra reward tokens, often vested over time, as a subsidy for early participation. Farmers frequently move funds between protocols chasing the highest return, a process that can be automated through vaults that compound positions and reinvest rewards.

Why It Matters

Yield farming drives the growth of DeFi by bootstrapping liquidity for new protocols, but it also carries real risk. Rewards are often paid in the protocol's own token, which can lose value, and the underlying positions face impermanent loss and smart contract risk. Returns that look high in token terms may be much lower in stable value, which is why APY figures must be read carefully.

Related Concepts

Yield farming's headline metric is APY, and its core risk is Impermanent Loss from Liquidity Pools. Vaults and aggregators automate compounding, while the broader category of Liquid Staking turns staking rewards into a tradable yield-bearing position.