What is Yield Farming and Liquidity Providing

Yield farming is one of the many memes that was created by the DeFi community. While it’s a term that gets tossed around loosely, there’s a narrower criteria to define what is yield farming:

1. It often requires providing liquidity or lending liquidity in a permissionless DeFi protocol to earn passive income.
2. It results in traders earning more than one form of yield simultaneously; a lending rate or liquidity provider fee, plus additional token rewards in the form of the protocol’s native token

Yield farming programs, also known as liquidity mining, was pioneered in DeFi by Synthetix, a protocol that offers on-chain exposure to any asset using derivatives. With yield farming, a protocol will reward its early users by paying them in the protocol native token, like COMP, YFI, and yes, even PICKLE and YAM.

It’s the equivalent of a Web3 customer acquisition cost–paying early users in the native token that powers your DeFi application and often involves voting rights in future upgrades to the protocol. Imagine if Facebook could have rewarded early Facebook users in their own Facebook token, which would allow users to vote on the future of Facebook and see some return in trading the token.

Today, we have even simpler examples of yield farming like on Compound Finance, where anyone who borrows or lends on Compound, continuously earns a portion of daily issued COMP, which is the governance token of Compound. COMP gives users a voice in the future upgrades and proposals of the Compound protocol–but they can also easily sell COMP on an AMM like Uniswap.

Yield farming is not just about earning yields over a short period of time on hyperinflationary tokens. When applied with well-designed incentives and a strong product-market fit in DeFi, yield farming can quickly bootstrap liquidity in the most promising future DeFi applications. It’s no coincidence Synthetix has remained one of the top 10 DeFi apps in TVL and users over the last 2 years.

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