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The Secret Passive Income Machine: Yield Farming - YouTube
Channel: Max Maher
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Since the summer of 2020, DeFi has been on fire.
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And many investors have turned to yield farming
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as a way to make even more capital with their capital.
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Now, many people use terms like yield farming,
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liquidity providing, and staking interchangeably,
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but there are differences in what they mean
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and how much money you can make.
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Staking refers broadly to the rewards that you get
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through the validation process of a
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proof-of-stake blockchain.
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Staking and yield farming are similar in the sense
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that they allow investors to earn
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return on their assets.
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But yield farming is a bit more intense,
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which means the potential for a higher return
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for an educated investor.
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So let's do some defining.
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Staking versus Yield farming - what's the difference?
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Starting with the more simple one: Staking.
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All cryptocurrencies have a consensus mechanism,
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which basically means they have a system
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that verifies transactions on their ledger.
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Those who verify transactions are
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paid for their efforts in crypto.
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The thing about verifying transactions
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is you can't make it easy to do.
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Otherwise, bad actors can come in
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and attack the system.
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So a good way to make it difficult to
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verify transactions is by requiring
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resources to do the verification.
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This can be done through mining a cryptocurrency
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like Bitcoin does, which needs a lot of electricity and
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powerful computers to verify transactions,
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or through staking your cryptocurrency.
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Now, Staking allows you to verify transactions
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by essentially locking up
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or staking that currency with a validator.
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The model basically says,
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if you have money in the system,
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you're unlikely to be a bad actor,
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so you can be paid staking rewards
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for locking up your currency and
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helping to facilitate the system.
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The rewards are paid in proportion
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to how much of that crypto you hold.
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So if you hold 100 coins,
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you'll receive ten times more Staking rewards
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than someone who holds 10 coins.
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Staking rewards are typically around
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4% to 10% annually,
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but some reach as high as 100% or more.
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Now, usually on the higher end, those are
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temporary rewards.
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Now, how do you stake your crypto?
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Unfortunately, each crypto is slightly different,
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but the most user-friendly way is
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by going through an exchange like Exodus or Binance
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who offers fairly good staking rewards.
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Otherwise, you can stake directly
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from your crypto wallet
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to what's called a stake pool.
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Now, this generally gets you the highest possible rewards.
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Staking is a great option if you
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plan on holding a crypto long term.
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Now, Yield farming.
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Yield farming takes a bit more effort
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and deeper understanding of cryptocurrencies
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and the risks involved.
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So buckle in.
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You're doing more than just
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putting your held coins in a
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stake pool to help facilitate transactions.
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Instead, you're allowing your coins
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to be used to facilitate transactions
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in a decentralized exchange,
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something like Uniswap or PancakeSwap.
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This is called providing liquidity
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in a liquidity pool,
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so your coins are used by a decentralized exchange
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to let other users borrow or trade cryptos
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through swaps.
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Now, swaps are literally
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swapping one coin for another.
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So swapping like Ethereum for Chainlink.
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I like to think of providing liquidity
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as a small business because you
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lock up your crypto in these liquidity pools
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and you're paid a percentage of
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all the transaction fees that that pool earns.
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So if you're providing 50% of
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liquidity in a pool, meaning 50% of the currency in that
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pool is your currency,
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you get paid 50% of the rewards,
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which means 50% of the fees generated
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you receive, which can be a lot of money.
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Now there's another layer to this comparison, and that's
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called liquidity mining.
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I know, stick with me here,
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I promise it will all makes sense.
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With liquidity mining, you're
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still allowing your coins to be used in a
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liquidity pool, and you're still earning a
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portion of the transaction fees.
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But on top of this,
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you also receive additional tokens,
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which you can trade on exchanges
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for additional cash.
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So let's do an example.
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You provide liquidity for an Ethereum-LINK swap,
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meaning you hold both of those cryptos
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and you're locking them up with
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the liquidity pool.
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With regular liquidity providing, you get paid
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your transaction fee rewards in Ethereum.
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With liquidity mining, you get your transaction fee rewards
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and additional tokens from the exchange.
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Let's call it token X.
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This means you can make even more money.
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So a real world example here
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is using a protocol like Compound Finance.
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You're rewarded with COMP governance tokens
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when you provide liquidity through their platform.
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So like other governance tokens,
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COMP also allows users
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who hold that token to vote
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on changes within the ecosystem,
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and you can still sell those tokens for cash.
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So this can be additional income
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from providing liquidity.
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Now that you know what yield farming is,
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let's talk top strategies.
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The most often used strategy
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for yield farming involves using an
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Automated Market Maker or an AMM.
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With an AMM you're required to invest
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in a trading pair.
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This is the swap that I mentioned earlier,
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like Ethereum and Chainlink, or whichever
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two cryptocurrencies that you hold
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that you could help facilitate those transactions.
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Most commonly, this is a stable coin though,
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like USDT or Dai,
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paired with a slightly more volatile asset like Ethereum.
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By doing so, you're providing
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liquidity to the AMM.
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You're doing that so users who would like
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to trade either one of those two assets
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are able to do so at a fairly stable price.
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The reward you get is again a
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cut of the trading fees
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in proportion to how much
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liquidity you're providing.
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The most popular places to do this
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are Uniswap, PancakeSwap,
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SushiSwap, and 1inch.
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In the near future, we'll have even more options
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once the Cardano ecosystem
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has their Dexes up and running.
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Now a side note here is there are AMMs
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which allow you to deposit just one kind of
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crypto asset instead of the pair.
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However, those are more rare,
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but this does put you at less risk of impermanent loss.
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More on that in a couple of minutes.
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Now, some high risk tolerance investors
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take this several steps further
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to earn even more money.
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What they do is they lend and borrow
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from different dApps to receive the highest
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amount in rewards possible.
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This is not something that I recommend.
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So basically, people will both lock up their tokens
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and borrow out tokens at the same time
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to increase exposure
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and then use those tokens that they're borrowing
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to provide liquidity elsewhere.
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It's like leverage liquidity and of course,
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it can get extremely risky, extremely fast.
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Again, not recommended.
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If you're new to this, stick to basic liquidity providing.
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Of course, not financial advice.
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The way I like to think of
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providing liquidity is how I like to think of staking.
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If you plan on holding a project long term,
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then this will just earn you extra income
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provided that you do your research first.
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So now let's talk about how much you can
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earn providing liquidity.
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And luckily there are tools that can help you
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calculate the returns before you ever even start.
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Here we can see that on Uniswap, if you provided $1,000 in an
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Ethereum-USDT pool, you can get a
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56% return given current rates.
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Now this is quite high returns,
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and of course, that is subject to volatility
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and other risks that we'll discuss in a second.
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A common strategy for success
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when providing liquidity is
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only joining pools with a lot of trading volume.
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So, popular coins.
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And this is because you need trades to happen
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within a pool for you to actually make money.
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So if you're providing liquidity for two
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rare coins, you're not going to make a whole lot of money.
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And now that we know what liquidity providing is
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and some strategies to make money,
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we need to talk risks.
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Do not skip this section.
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The first risk is a Rug Pull.
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When you're buying new crypto tokens
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for a project that hasn't launched officially,
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you run the risk that that team will
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take that money and run without ever
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completing the project.
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And this also applies to
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DeFi projects where a new liquidity pool
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might promise you returns in the
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1000 or even million percent range.
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But then it gets shut down,
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before you see any returns on your investment.
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- Please shut down the system.
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And the scammers, of course, run away with
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deposited funds.
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Now this can absolutely be
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avoided by just sticking with popular
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apps and doing your research beforehand.
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And then you have the risk of providing liquidity
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for a crypto with bad market mechanics.
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And this actually happened to Mark Cuban
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just a couple months ago.
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He was providing liquidity for a
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crypto project that included a crypto
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called Titan and Iron.
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Iron was an algorithmic stablecoin
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tied in price to the other crypto
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within the pool Titan.
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And then there was some selling pressure on Titan,
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and this actually caused both the cryptos to
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spiral down to nearly zero almost instantly.
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And everyone basically lost
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all their money, including Mark Cuban.
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And this happened because the stablecoin was simply
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poorly designed.
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Pretty crazy.
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But again, a situation like this
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is totally avoidable.
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This swap was advertising
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2 to 4 million percent annual returns.
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So greediness gets you in trouble,
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even if you're a billionaire.
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Now, the last risk to consider is
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Impermanent Loss.
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This occurs when you've deposited two assets
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into a double sided liquidity pool
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where it's required that you deposit the same amount
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of two different tokens.
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Now it's necessary to do this in most cases,
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because many exchanges need you to have a
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a proportional amount of both tokens.
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for users to borrow against the pair.
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Now, what happens is as the price of
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your two cryptos change,
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the proportion of each coin you hold
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changes automatically in the liquidity pool,
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and this happens in order to keep that ratio
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at 50-50 for each crypto.
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Now, this can be an issue if one of the tokens that you deposit
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skyrockets in price
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because your position of the skyrocketing coin,
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will begin to sell off to keep
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that proportion at 50-50.
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And here's where the problem comes in.
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If a crypto in your pair,
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let's say doubles in prize,
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you would have actually made more money by just
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holding that coin
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instead of using it to provide liquidity.
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Impermanent loss is kind of like
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opportunity cost of providing liquidity.
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Opportunity cost that you may miss out on monster gains,
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but this only happens
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if one coin takes off and the other doesn't,
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again because of that proportion balance.
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Now, I don't want to worry you too much
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because there are methods to limit this issue,
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and it's much less an issue now
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than a couple of years ago.
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On Uniswap, for example, you can choose the
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trading range, and if prices go beyond that
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range, so if that crypto doubles,
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the pair will stop rebalancing,
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meaning you won't lose all of that upside.
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So in summary, providing liquidity can be a great way to
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earn a bit more money on the crypto that you
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plan to hold long term.
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This is generally a stable way to
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earn more money so long as you
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aren't holding super high risk projects
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and you're not letting greed get
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the best of you, which I know is sometimes hard to do.
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So if you feel a little bit lost in the world of crypto after watching this,
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and would like a more hands on approach,
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you may want to consider joining my Patreon,
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which is linked in the description below.
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In there you'll find additional private content,
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live coaching, and a private community to
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bounce ideas and ask even more questions.
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I think you'd really like it.
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So I'd like to thank you so much for watching
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and I hope you have a profitable day.
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