The 4 Biggest Mistakes To Avoid When You Start Yield Farming
Yield farming stablecoins is a great way to earn high yields without being directly exposed to the price volatility of crypto assets. However, there are things that you should be aware of when you’re first starting out. In this article, we’re going to outline some of the key mistakes people usually make when they start farming.
#1 Deposit fees
The first thing to be aware of is the deposit fee. Some farms charge deposit fees, which means if you deposit 100 USDC, and the deposit fee is 2%, then you’ll have 98 USDC left to farm.
Here’s a screenshot from trickortreat.farm (there’s no liquidity, so don’t bother to farm there):
This doesn’t sound like a big deal, especially when the farm is promising a very high yield. As a result, a lot of people consider this to be a non-issue. However, even with around 50% APR it takes around 2 weeks to recoup that 2% deposit fee.
But 50% APR is a very high yield that’s usually not sustainable. As farms attract more capital, the yield usually decreases. This means that the time it takes for you to earn back that 2 USDC that you paid as a deposit fee will increase as well.
For instance, stablecoin yields often come down to 10% or less (still high yield compared to traditional finance), which means it can take months to earn back that deposit fee.
Be aware of deposit fees and we recommend you to avoid using farms where deposit fee is charged.
#2 Withdrawal Fees
Remember that protocols have to earn money in order to upkeep the business. Because of that, some fee structure is always applied.
One of the ways that the yield aggregator can monetize the protocol is the withdrawal fee. But here’s an important distinction — some protocols charge a withdrawal fee from the whole sum, while some charge a fee only from the earned yield. The latter option is a lot better for you as a user, and it is also the structure Clip Finance uses to earn revenue.
If the protocol doesn’t charge anything on the principal, and only charges a fee from the yield, then you’re still making a profit from day one, as you don’t have to earn back any paid fees. Additionally, it also means that the yield aggregator is incentivized to maximise the yields of the users, as otherwise protocol revenues aren’t enough to keep up with the costs of running the aggregator.
Either way, it’s wise to use yield aggregators that auto compound your stake without having to pay withdrawal and transaction fees every time to sell your earned tokens back to the liquidity pool.
#3 Farm Governance Tokens And Not Sell Them
Many farms give an extra incentive to use the farm by rewarding you with their own native token in addition to the yield of the deposited token. This enables the farms to promise higher yields by simply minting more tokens (i.e. the token is inflationary). Most of the time the price of these tokens trends downwards.
Here are screenshots of charts of different protocol tokens — and some of these protocols do a lot more than just farm (TraderJoe is the biggest DEX on Avalanche blockchain, and Sushiswap is one of the biggest DEXes in the whole crypto space). Because of the lack of utility and inflationary tokenomics that subsidize the extra yield, there’s usually a selling pressure for these tokens.
As you can see even the biggest exchanges (where users can earn fees from trading as an additional incentive to hold the token) suffer from the same price action. To be fair, some protocols have better tokenomics than others, and it makes sense to understand tokenomics and what drives value to the token every time you decide to keep a governance token as part of your portfolio. But remember that when the tokens you earn as a yield lose value, it also means your APY will be considerably different than what the farm promised.
What can you do to have less exposure to the price risk of the earned tokens? One solution is to use yield aggregators that auto compound your rewards. The aggregator sells the earned tokens back to the liquidity pool several times per day (or whatever frequency is written to the smart contract’s strategy), and thus limits your exposure to these tokens.
Without the auto compounding feature, you need to harvest and swap your rewards yourself to stablecoins, and re-invest to increase your principal and thus earned rewards. This means you’ll have transaction and withdrawal fees each time you’re doing it, not to mention the time investment.
Again, good tokenomics can make it worthwhile to keep all or the portion of the earned rewards in the native tokens of the protocol. But there are risks involved and most of the time it’s wise to use a yield aggregator that will auto compound your rewards.
#4 Using Centralized Services
There are a few centralized services that are widely used to earn yield because of the perceived safety. They’re backed by big investors, licensed, and have a trustworthy corporate look. There are upsides to using these services, i.e. they’re usually easy to use (other than having to do a KYC) and sometimes have at least some sort of insurance for deposits (which is possible in DeFi as well).
However, there are notable downsides to centralized services. For one, they often provide at least 2x lower yield. While DeFi solutions run on smart contracts, centralized services have a lot of overhead due to big staff and regulatory requirements, and thus it’s difficult for them to provide a similar yield to their users.
Additionally, as we’ve seen with the example of Canada and the growing tendency of states to use authoritarian measures to control people (i.e. weaponizing financial institutions), it’s easy to see why using decentralized protocols makes sense. I believe this argument will become a lot more important in the coming years.
Conclusion
These are some of the common mistakes people usually do when they start yield farming. We believe that Clip Finance helps you to avoid these mistakes as we’ve structured the protocol so you could farm without having to go through the sometimes costly learning curve.
And if you do decide to not use a yield aggregator like Clip, but farm manually instead, make sure you don’t stumble upon these mistakes as they can be expensive.
