What is DeFi Yield Farming: Structure And Importance in Decentralized Finance

What is DeFi Yield Farming?

Decentralized Finance, or DeFi, is a system through which financial products become available on a public decentralized blockchain network. This enables the availability of these financial products to everyone, rather than going through middlemen like banks or brokerages. Hence, there is no need for a third party to be involved in it.

Unlike a bank or brokerage account, the need for government-issued ID, Social Security number, or proof of address are not necessary thereby highlighting it’s uniqueness and desirability.

Significantly, DeFi refers to a system by which software written on blockchains makes it possible for buyers, sellers, lenders, and borrowers to interact peer-to-peer or with strictly software-based middleman rather than a company or institution facilitating a transaction.

The aim of DeFi is replacing traditional intermediary systems with new and improved technology between parties in a financial transaction

 

Advantages

  • Traditional banks are costly while decentralized bank is much cheaper.
  • Open to anyone regardless of ethnicity, age or cultural identity.
  • Trustless system: It does not scam.
  • At the same time, DeFi applications provide users with more control over their money through personal wallets and trading services.
  • One of the best sources of passive income.

DeFi Yield Farming

  • Yield farming is a way to make more crypto with your current existing crypto. It maximizes the rate of return on capital. Basically, it involves lending of funds to others through computer programs called smart contracts. In return for service, one can earn fees in the form of crypto.
  • Yield farming, also referred to as liquidity mining that is to generate rewards with cryptocurrency holdings. In simple terms, it implies locking up of cryptocurrencies and getting rewards.
  • In many cases, it works with users called liquidity providers (LP) that add funds to liquidity pools. Some liquidity pools pay their rewards in various tokens. Those reward tokens then may be deposited to other liquidity pools to earn more rewards.
  • Yield farmers can move their funds around different protocols in search of high yields. As a result, DeFi platforms may also provide other economic incentives to attract more capital as liquidity tends to attract more liquidity.

Requirements of Decentralize Finance (DeFi)

  • Cryptography: it is the study of secure communication techniques that allow only the sender and intended recipient of a message to view its contents. The data is encrypted using a secret key, and then both the encoded message and secret key are sent to the recipient for decryption.
  • Blockchain Technology: Blockchain is a system of recording information in a way that makes it difficult or impossible to change, hack, or cheat the system. A blockchain is essentially a digital ledger of transactions that is duplicated and distributed across the entire network of computer systems on the blockchain.
  • Smart Contracts: Smart contracts are simply programs stored on a blockchain that run when predetermined conditions are met. These are used to automate the execution of an agreement so that all participants can be immediately certain of the outcome, without any intermediary’s involvement or time loss.

Components of DeFi

At a broad level, the components of DeFi are the same as those for existing financial ecosystems. This means they require stable currencies and a wide variety of use cases. All components of a decentralized finance system belong to a software stack.

Four layers that comprise the DeFi stack:

  • Settlement Layer: The settlement layer is also called a Layer 0 because it is the base layer upon which other DeFi transactions are built. It consists of a public blockchain and cryptocurrency. eg.of the settlement layer is Ethereum and its token ether (ETH), which is traded at crypto exchanges. The settlement layer can also have tokenized versions of assets, such as the U.S. dollar, or tokens that are digital representations of real-world assets.
  • Protocol Layer: Software protocols are standards and rules written to govern specific tasks or activities. All the participants have to follow these rules and principles.
  • Application Layer: Here consumer-facing applications reside. Such common applications in the cryptocurrency ecosystem are decentralized cryptocurrency exchanges and lending services.
  • Aggregation Layer: It consists of aggregators who connect various applications from the above layer to provide a service to investors. For example, they might enable the seamless transfer of money between different financial instruments to maximize returns.

Benefits and Importance of Decentralized Finance

Decentralized finance leverages key principles of the Ethereum blockchain to increase financial security and transparency, unlock liquidity and growth opportunities, and support an integrated and standardized economic system.

Here are some unique features that make DeFi very attractive to investors;

  • Programmability
  • Inexpensive
  • Immutability
  • Interoperability
  • Transparency
  • Trustlessness
  • Permissionless
  • Self-Custody

Undoubtedly, DeFi money markets can help create a more open and accessible financial system available for anyone.

 

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