Yield farming is moving crypto between DeFi protocols to collect the best return on offer. That's all the phrase means. The skill isn't finding the biggest number. It's knowing where the number comes from, because some yields are paid by real customers and some are paid by printing tokens, and the second kind ends.

Three places a yield can come from

  • Trading fees. Your share of what traders pay to swap through a pool you've funded. Real money from real users. Our liquidity pools guide shows the mechanics.
  • Lending interest. What borrowers pay on a lending protocol like Aave. Also real, and it rises and falls with demand to borrow.
  • Token rewards. New tokens the protocol mints and hands out to attract deposits. This is where the eye-watering percentages live, and it's only worth anything while people want to buy the token you're being paid in.
An illustrative 40% advertised APY broken into its sources AN ADVERTISED 40% APY, TAKEN APART (ILLUSTRATIVE) 4% 3% 33% paid in the protocol's own new tokens Trading fees: paid by real traders Lending interest: paid by real borrowers Token rewards: worth only what the next buyer pays for the token If the reward token halves, this "40%" becomes roughly 23%. If it goes to zero, you're left with 7%.
A made-up but typical split. Ask what share of any yield is the orange part before you deposit.

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AI presenter. Written by Robert Stone. More in our DeFi Explained for Beginners playlist.

How the game started, and how one version ended

In June 2020 Compound started paying its COMP token to anyone who lent or borrowed on it. Deposits poured in, every rival copied the trick, and the summer got a nickname: DeFi Summer. Token rewards worked brilliantly at pulling money in.

33%of an illustrative 40% APY paid in new reward tokens
7%what that 40% falls to if the reward token goes to zero
~20%Anchor's rate on UST before the May 2022 collapse

⚠ Red flag

Two years later Terra showed the other end. Its Anchor protocol offered close to 20% on the UST stablecoin, a rate no real borrowing demand could pay for. When UST lost its dollar peg in May 2022, the whole system collapsed within days and tens of billions in value went with it. A number that high with nothing real underneath it was the warning.

What a farm looks like in practice

The basic loop: put two tokens into a pool, get LP tokens back, then stake those LP tokens in a separate rewards contract to earn a bonus token on top of the swap fees. The fancier strategies stack this across several protocols and chains. Each layer adds a little yield and one more thing that can break.

The risks, plainly

  • Code. Every protocol in the chain is another contract that can be exploited.
  • Impermanent loss. If a pool is involved, price moves can quietly eat the yield.
  • The reward token. As more gets minted and farmers sell it, the price tends to slide. Your APY slides with it.
  • Stacking. Route money through four protocols and you carry the risk of all four, not just the last one.

A two-minute check before you farm anything

Find out how much of the yield is fees and interest, and how much is token rewards. Check how long the protocol has been live and whether its audits are public. Look at the total value locked and whether it's been rising or draining. And treat any triple-digit percentage on a new pool as a question to answer, not a reason to hurry. The higher and newer the number, the harder you should look.