Yield farming is simply the practice of using your crypto assets to earn additional rewards, usually in the form of additional cryptocurrencies.
For Homora, we focus on the practice of providing liquidity to a liquidity pool on a certain AMM protocol to receive additional incentives, which we call yield farming.
Liquidity providing is the practice of providing tokens in 50/50 ratio of equal value to a liquidity pool. When users provide liquidity, they receive a “receipt” back in the form of LP tokens to represent their share of the pool. AMM protocols often reward liquidity providers with additional tokens, calculating the rewards using the amount of LP tokens users hold and the respective APR (Annual Percentage Rate) for that pool. This together makes up the practice of yield farming.
We will provide the example with easy numbers for simplicity.
Let’s say at the time of writing, 1 ETH: 2000 USDC. Alice has both of these tokens and is interested in becoming a liquidity provider to ETH/USDC pool on a certain AMM protocol.
We will call this AMM protocol “Protocol A” and the yield farming reward as “Token A”.
In order to become a liquidity provider, Alice will have to supply ETH and USDC of equal value (50:50). She supplies 5 ETH and 10,000 USDC and receives LP token back from Protocol A.
Now that Alice holds a certain amount of LP tokens, she has now become a liquidity provider in ETH/USDC pool and is eligible to receive Token A from Protocol A. That’s how yield farming works in a nutshell!