Yield farming, a cryptocurrency investment strategy, offers the possibility of higher returns than conventional investments. This could offer the chance to win big, or allow holders of new currencies and traders to manipulate the prices. The U.S. Securities and Exchange Commission has notified the industry that it has concerns, particularly about whether this practice should be regulated under the securities offering regulation.
What is Yield farming?
You are effectively lending money to a bank by depositing money. In return, you receive interest. Yield farming is also known as liquidity harvesting or yield. It involves lending cryptocurrency. You get interested and fees in return. They are however less important than supplementing your interest with handouts to buy units of a cryptocurrency. If the coin appreciates quickly, that’s when you get the real reward. It’s almost as if banks lured new depositors with the gift of a tulip — during Dutch tulip fever. Or a toaster, if toasters were the subject of wild speculations and price swings.
Although it may sound odd, you should remember that cryptocurrencies must balance out existing currencies, which have a lot of money. The currency is only worth what people actually use, so it’s important to encourage the issue of new units in order to increase its user base.
However, flooding the market would make it less valuable. (Remember that cryptocurrencies are valued more as commodities whose prices may rise with demand rather than their utility in real-world transactions which is the main purpose of the dollar, euro, or yuan.
Also read: How to do Free Bitcoin Mining
How does it all work?
First, what is a dapp? A dapp is shorthand for a decentralized application. Vitalik Buterin, the co-founder of Ethereum, explains the concept using this analogy: If Bitcoin is a pocket calculator then platforms with dapps can be considered smartphones. However, automated programs that run on dapps do not require a central operating system. Many of them use the Ethereum blockchain, which is a digital ledger.
Okay, so how does that work?
The simplest approach is to lend digital currencies, such as DAI and Tether, via a dapp like Compound. The coins are then loaned to borrowers who will use them frequently for speculation. Interest rates may vary depending on demand. However, each day you participate in the Compound service, you will receive Comp coins and interest.Your returns will skyrocket if the Comp token appreciates, which it has more than doubled since mid-June.
What does the SEC do?
Coinbase Global Inc. stated that in September the agency threatened to sue if customers were allowed to earn interest on certain digital tokens. Coinbase’s Lend product is at issue. Although it had not been made available to investors, the company promised that it would allow them to earn 4% per year by lending their USDC virtual tokens.
The USDC is a stable coin, which is offered by a group of companies including Coinbase. It allows traders to convert digital assets into cash or vice versa. The SEC’s dispute with Coinbase became public when Paul Grewal (the company’s chief lawyer) stated that the SEC had determined that Lend was “a security” and that they intended to sue the company if they launch Lend.
What is the problem?
Coinbase may be confused, but the SEC long maintained that a wide range of tokens is within its jurisdiction. The SEC has maintained that digital assets can be considered investment contracts or securities over the past four years. This is based on the Howey Test, a legal theory that was first presented in a case before the Supreme Court in 1940. According to the regulator, almost anything that allows investors to expect profit from the work done by others can be considered an investment contract.
The industry countered that the SEC’s view was too vague and inappropriate for virtual coins. Companies like BlockFi Inc. and Gemini Trust Co. are likely to be concerned about the move. They offer services that allow clients to earn interest in lending their tokens. New Jersey is one of the states that has ordered BlockFi to cease marketing certain products.
Are there any other types of coins?
The compound was launched in June and is currently one of the most popular such services. It has approximately $11 billion in funds according to tracker Defi Pulse. Balancer, Synthetix, and Curve are also major players in the game. The idea was pioneered by Synthetix. These services now have more than $90 trillion in locked user funds. These funds are money that can be used to lend. Comp holders can, supposedly, participate in the governance of these networks and their improvement. However, the majority of those who use them are speculators trying to make fairy-tale-like returns.
What are the potential risks?
Theft is a serious threat beyond regulatory crackdowns. Digital money that you lend is actually held by software. Hackers seem to be able to exploit weaknesses in code to steal funds. People deposit coins for yield farming, but they are only a few decades old.
They could lose their value and cause the whole system to crash. Additionally, early investors hold large amounts of reward tokens and could cause a significant impact on the price of tokens. Finally, regulators have yet to decide whether reward tokens can or should be considered securities. This could have a significant impact on the value and use of the coins.
What could possibly go wrong?
Liquidation is a risk associated with many high-yield harvesting techniques. Many users adopt complex strategies to maximize their returns. Some investors have used Compound to deposit DAI tokens, then borrowed DAI with initial tokens as collateral, and then lent the funds out. To get more of the rewards, you will need to collect Comp tokens. Any move in the wrong direction could result in the loss of all gains or trigger liquidations.
What’s the latest?
For many years, people have been able to earn interest by lending their cryptocurrency through apps such as BlockFi. This is part of the trend of decentralized financing or DeFi. In which middlemen like banks are replaced by automated protocols of dapps, this is a way for people to make money. The compound is a new venture that gives tokens to borrowers and lenders, often with implied rights to cash flows in the future. It was designed to provide people with “skin in games” by incentivizing them to take part in improving and governing the networks.
What about market manipulation?
If someone lends a cryptocurrency to Compound and then borrows it back they create artificial demand for the coins, which in turn drives up their prices. This has raised concerns about early adopters, sometimes called whales, manipulating price movements. It is a common accusation in crypto markets. According to Messari, a crypto research firm Messari, yield harvesting has “become a game for whales that are capturing the vast majority rewards.” Small traders need to be aware.
Is this why it is so popular right now?
There are a couple of reasons. First, cryptocurrencies have seen an increase in interest due to the high volatility of traditional assets. Many of the yield-harvesting products were launched this summer and offer attractive tokens for rewards. They boast high-profile backers such as Andreessen Horowitz, Polychain, and Polychain.