I recently came across an article in Entrepreneur magazine on 4 ways to make passive income using Defi. This sounded enticing as I had some crypto lying around waiting on higher highs. Getting rewarded for providing liquidity to currency pairs sounded interesting so I decided to dig deeper.
What is Yield Farming?
Please note that in this article I am not giving financial advice. Yield farming, staking and crypto investments in general are high risk and you’re in the Wild West of Finance. You could lose all your investments – therefore tread with care.
Yield farming is based on the idea that you purchase LP (Liquidity Provider) tokens and add that to a specific currency pair to provide liquidity to trades taking place. You are rewarded based on the ratio of tokens already in the pool. The fewer investors present in the pool means you get a larger portion of the rewards. If the pool is flooded with LP tokens, the ratio of your LP tokens relative to pool size reduce and you are left with a smaller APR.
Not only can the promised returns drop, but you also run the risk of losing a part of your capital contribution if there are massive fluctuation rates of the trading pair. This is called impermanent loss and is described here.
To Ethereum or Not
Uniswap is at time of writing the largest (by marketcap) liquidity provider on the Ethereum eco system. I was ready to dip my toe into the water, had my Metamask wallet connected up and was about to approve the trade, when I saw to my horror that the transaction fee (GAS) would be over $60.
— Daily Blockchain News (@dailyblocknews) February 9, 2021
Why I Did Not Go the Ethereum Route
Why do Ethereum transaction fees run so high? The bigger the volume of trade on the Ethereum network, the higher GAS fees run up. This is in essence a congestion penalty fee due to the slower Proof-of-Work consensus mechanism. It lags behind in transactions processed per second as compared to its more progressive Proof-of-Stake rivals.
I had a look at some of the competition in the market, in particular Pancakeswap based on the Binance Smart Chain. As with Uniswap, PancakeSwap is a DEX or decentralized exchange platform that is an AMM (Automated Money Maker) and provides liquidity in peer-to-peer trades. The tokens it trades with on the Binance network are BEP-20.
On Pancakeswap, the cost of a transaction works out to about 15c which makes a lot more sense to small investors like me. Many distributed disciples might complain about the centralized nature of Binance, but paying up to $100 or more as transaction cost on the Ethereum network does not make sense for the small amounts I invest.
How to Get Money Into Pancake
1] First off you will need some binance or BNB coin. If you are in the US, BNB is not sold on Coindesk. Therefore check here to see if your country allows access to Binance. Have a look at this article to see how you can get money into Binance. Here is an article explaining how you can purchase BNB.
2] Get the BNB onto a Metamask wallet. Binance has a step by step article on how to download Metamask for Chrome and setup the Binance Smart Chain on Metamask. A Binance Chain Wallet chrome extension exists, but as you’ll see from the reviews on the download site, there are still too many issues that need sorting out. Besides, Metamask can easily be configured to work with BEP-20. To get BNB onto Metamask, a withdrawal is needed from Binance to Metamask.
3] Link MetaMask to Pancakeswap. Head over to Pancakeswap to see what they offer. On the page, you need to link your Metamask wallet. In the top right corner, click on “Connect”.
Your wallet address should now be displayed in the top right corner.
Which Pair to Farm?
The Farms section has a large list of available token pairs. APR (annual percentage rate) is an indication of the returns over a year. This is not to be confused with APY (Average Percentage Yield) where the profits are consistently compounded with the lump sum to project a bigger profit after a year. APY will always look better than APR.
Due to the risks of impermanent loss mentioned above it might be wiser to get look at pairs that do not lose a massive amount of ground against one another. In the EPS-BNB pair above the return is a massive 428% percent, but compare their price history and you’ll see that these are two currency pairs that do not keep in step with one another and your capital will be eaten away.
A better idea might be to find a pair of stable coins that is connected to the same fiat currency. The APR is not stellar, but massive divergence should hopefully not occur meaning less risk of loss for your investment capital.
The Pancake documentation has a good step by step article on how to to purchase LP tokens for yield farms.
The author holds Unisawp, BNB And Cake coin.