Yield Farming vs. Liquidity Pool

Yield Farming vs. Liquidity Pool

Yield Farming vs. Liquidity Pools How it differentiates and used within DeFi

As cryptocurrencies are being more widely accepted, more investment methods have begun to pop up, appearing in the forms of Staking, Yield Farming or Liquidity Pool.



Although the crypto market is more volatile than other markets, making short-term trading more profitable than less volatile markets, the growth rate of various digital assets has effectively been growing rapidly, resulting in high attraction of more long-term investors who accumulate continuously, or known as DCA (Dollar Cost Averaging) investors, to join the market.



With an increase in long-term investors, revenue generation was erected for investors who hold various cryptocurrencies to attract the aforementioned long-term investors to different platforms or networks.





What is Yield Farming?



Yield Farming is an investment method elaborated on DeFi (Decentralized Finance) platforms that function automatically through smart contracts where users can invest their cryptocurrencies to earn rewards.



By depositing cryptocurrencies held by investors into the system to provide liquidity or known as a Liquidity Provider, users may receive returns in the same currency as deposited or other currencies, depending on each platform.



When investors deposit funds into the system to provide liquidity to DeFi, in addition to the return on the user's fees, additional native platform tokens can be earned as well. Investors use the tokens in many ways whether it is depositing, borrowing, or providing liquidity which depends on the conditions that the creator set.



When examining closely, one can see that Yield Farming works very similarly to an Automated Market Maker (AMM) platform with components like Liquidity Provider and Liquidity Pool instead of an order book trading platform.





What is Liquidity Pool?



Liquidity Pool is like a treasury of cryptocurrencies deposited by users through smart contracts to enhance liquidity to Decentralized Exchanges (DEX), lending platforms, and other financial services, to provide cryptocurrencies to people in need.



Decentralized Exchange (DEX) is functioned by an Automated Market Maker system where buyers and sellers can transact instantly without having to match buyers with sellers but it will pull the assets in the pool or Liquidity Pool that the liquidity providers have deposited, which the user will have to pay a fee for the service and that fee will be a reward to the liquidity provider.



The return that liquidity providers will receive is calculated as APY (Annual Percent Yield) or APR (Annual Percent Rate), which is one of the factors investors consider when choosing to invest in a particular DeFi, which APY and APR might be changing all the time depending on the amount of Total Value Locked.



There are various methods of depositing coins such as depositing a single coin, coins in pairs, or multiple coins with fixed ratios such as DAI, ETH/USDT, or DAI/USDC/USDT.









Difference between Yield Farming and Liquidity Pool

Yield Farming is an investment means carried through various DeFi platforms where investors deposit cryptocurrencies to provide liquidity to the platform. There are many types of DeFi services, such as exchanging, borrowing, and lending. When users utilize services and pay for the fees, they are then shared with the liquidity provider as return rewards.



Liquidity Pool is a pool reserve of different cryptocurrencies that are accepted by the platform to prepare for usage with an Automated Market Maker (AMM) system, which is a mechanism designed through the work of smart contracts. 



Liquidity Pool is one of the mechanisms within DeFi (Decentralized Finance) that everyone has heard of nowadays, while Yield Farming is a form of investment made through DeFi. By understanding this fact, will help investors to have a clear picture in their head and have more understanding about Yield Farming and Liquidity Pool.





Conclusion



In the world of cryptocurrencies, investment does not only encircle just the area of trading, also various other types of investments. High-yield investments often come with increased risk, so investors should study for in-depth information before making any investment decisions.





Reference:

Coinmarketcap, Coindesk, Finematics

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