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Listen "Crypto Yield Farming"
Episode Synopsis
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Check out this edition of the newsletter with all references and Tech Under A Minute here: https://techbreakdowns.substack.com/p/understanding-crypto-yield-farming
The traditional form of investing in cryptocurrencies is buying them off an exchange, holding them in a digital wallet, and then if you’re lucky, selling them for a higher price than what you paid for it. There is nothing wrong with it, this is how most people also invest in stocks. But, imagine, a way that your crypto could make money while you hodl it.
You very likely understand how a bank works – depositors deposit; borrowers borrow; borrower pay interest; depositors get interest. In the end, for the depositors, their money makes them more money. That’s the whole idea behind banks – to not have money sit idle. Yield farming or liquidity harvesting is essentially the same thing with cryptocurrencies, except it’s decentralised and you get more than just interest on it.
Liquidity Pool
Simply put, liquidity pools are a digital stockpile of funds. They are permissionless – anyone can deposit funds in these pools. Users, called liquidity providers (LP), deposit two different tokens (coins) of equal value in this stockpile. For example, in a liquidity pool made up of Solana (SOL) and Ethereum (ETH), you would have to deposit an equal amount of SOL and ETH to the pool.
What’s the use of the pool? Continuing the previous example, say someone holds SOL and wants to do a transaction on the Ethereum blockchain. Now this person can go to an exchange, sell his SOL and buy ETH, paying high gas prices (transaction fees) each time, or he could just go to a liquidity pool and swap his SOL for ETH, paying only a minor transaction fee. (The latter is also faster).
What’s in it for the liquidity providers (LP)? As you could guess, the transaction fees that someone pays to access the liquidity pool is paid out to the LPs. But that’s not all, additional rewards are paid to the LPs in the form of governance tokens.
Governance Tokens
Governance tokens, came into prominence when compound.finance started issuing COMP tokens (coins) to its users for every day’s participation in Compound’s services. Remember, a currency only has values if a large enough group of people use it. Soon, the value of COMP skyrocketed and yield farming became a thing. As an LP, you can then speculate and trade the value of the tokens you receive. Here’s the crazy part - you can pool these governance tokens too!
Check out this edition of the newsletter with all references and Tech Under A Minute here: https://techbreakdowns.substack.com/p/understanding-crypto-yield-farming
The traditional form of investing in cryptocurrencies is buying them off an exchange, holding them in a digital wallet, and then if you’re lucky, selling them for a higher price than what you paid for it. There is nothing wrong with it, this is how most people also invest in stocks. But, imagine, a way that your crypto could make money while you hodl it.
You very likely understand how a bank works – depositors deposit; borrowers borrow; borrower pay interest; depositors get interest. In the end, for the depositors, their money makes them more money. That’s the whole idea behind banks – to not have money sit idle. Yield farming or liquidity harvesting is essentially the same thing with cryptocurrencies, except it’s decentralised and you get more than just interest on it.
Liquidity Pool
Simply put, liquidity pools are a digital stockpile of funds. They are permissionless – anyone can deposit funds in these pools. Users, called liquidity providers (LP), deposit two different tokens (coins) of equal value in this stockpile. For example, in a liquidity pool made up of Solana (SOL) and Ethereum (ETH), you would have to deposit an equal amount of SOL and ETH to the pool.
What’s the use of the pool? Continuing the previous example, say someone holds SOL and wants to do a transaction on the Ethereum blockchain. Now this person can go to an exchange, sell his SOL and buy ETH, paying high gas prices (transaction fees) each time, or he could just go to a liquidity pool and swap his SOL for ETH, paying only a minor transaction fee. (The latter is also faster).
What’s in it for the liquidity providers (LP)? As you could guess, the transaction fees that someone pays to access the liquidity pool is paid out to the LPs. But that’s not all, additional rewards are paid to the LPs in the form of governance tokens.
Governance Tokens
Governance tokens, came into prominence when compound.finance started issuing COMP tokens (coins) to its users for every day’s participation in Compound’s services. Remember, a currency only has values if a large enough group of people use it. Soon, the value of COMP skyrocketed and yield farming became a thing. As an LP, you can then speculate and trade the value of the tokens you receive. Here’s the crazy part - you can pool these governance tokens too!
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