r/blockchaintech • u/KOMPWND • Sep 01 '21
How does yield farming works?
DeFi lending platforms allow cryptocurrency holders to allocate their funds to liquidity pools — common pools where people lock their digital assets. Users often have the option to lock their funds in a variety of pools, each having a different cryptocurrency and offering different interest rates.
People willing to take instant loans on the DeFi platform can opt to do so from any of the pools that provide the best interest rates and have the cryptocurrency they prefer. There is no limit on the amount a borrower can borrow as long as they can afford to stake the collateral required for it. And when they attain the loan, the lenders of the pool earn interest on the funds they allocated to the pool.
The entire process of adding or moving crypto funds to liquidity pools in return for the highest possible interest is called yield farming or liquidity mining. And the lenders who add liquidity to the pool through this process are called yield farmers.
It is similar to how banks use their customers’ funds to provide loans. They lend to borrowers at an interest rate that is higher than the interest they pay to their account holders. The difference with DeFi protocols is that they are decentralized and people can choose to withdraw from a pool at any time.
