Yield Farming Explained: How DeFi Yield Works
Yield farming is the practice of putting crypto assets to work across DeFi protocols to earn returns — lending interest, trading fees, governance token rewards, or a combination. At its simplest, it is depositing USDC into a lending market. At its most complex, it is routing capital through multiple protocols simultaneously to stack yields.
Where yield comes from
Yield in DeFi is generated from real economic activity: borrowers pay interest on loans from lending protocols like Aave; traders pay fees to liquidity providers on DEXs; stakers earn new token issuance for securing the network.
During bull markets and new protocol launches, an additional source is liquidity mining: protocols distribute governance tokens to attract liquidity. This can push advertised APYs into triple or quadruple digits — but those rates are only sustainable as long as the governance token price holds and the protocol has new depositors. When liquidity mining rewards taper off, yields normalize dramatically.
Liquidity provision on DEXs
Depositing into a DEX liquidity pool earns a share of every trade routed through that pool. On Uniswap v3, the fee tiers are 0.05%, 0.3%, or 1% per trade depending on the pool. The risk is impermanent loss: if the price ratio between the two tokens shifts, you end up holding more of the cheaper one relative to just holding both tokens outside the pool.
Stablecoin-to-stablecoin pools on Curve Finance avoid impermanent loss because both assets target the same price. This makes stablecoin LP positions a common base strategy for conservative yield farmers.
Yield farming projects on ChainClarity
- Aave — the largest DeFi lending protocol; primary yield source for stablecoin depositors
- Ethereum — base layer for most yield farming strategies
- Polygon — low-fee Layer 2 with active farming opportunities
- Chainlink — oracle feeds that underpin lending collateral ratios and liquidation triggers
Browse all DeFi protocols →
Frequently asked questions
What is yield farming?
Yield farming is the practice of deploying crypto assets into DeFi protocols — lending markets, liquidity pools, or staking contracts — to earn returns. A yield farmer might deposit USDC into Aave to earn lending interest, then supply that Aave receipt token as collateral elsewhere to borrow more assets, compounding yield across multiple protocols simultaneously.
What is liquidity mining?
Liquidity mining is a specific form of yield farming where a DeFi protocol distributes its governance token as an additional reward on top of regular fees. By providing liquidity, users earn both trading fees and protocol tokens. This was the mechanism that drove the 'DeFi Summer' of 2020 — Compound's COMP distribution triggered a wave of protocols competing for liquidity by offering their own tokens.
What is the difference between APY and APR?
APR (annual percentage rate) is the simple annualized rate without compounding. APY (annual percentage yield) includes the effect of compounding returns. For example, a 100% APR with daily compounding becomes ~271% APY. DeFi protocols often display APY to make yields look larger. Always check which metric is being shown and whether the underlying rate is sustainable or driven by temporary token incentives.
What are LP tokens?
LP (liquidity provider) tokens are receipt tokens issued when you deposit funds into a DEX liquidity pool. They represent your proportional share of the pool and automatically accumulate trading fees. You redeem LP tokens to withdraw your share of the pool plus fees. LP tokens can themselves be deposited into yield farms for additional rewards — this is called 'stacking yield.'
What are the risks of yield farming?
The main risks are: smart contract exploits (the protocol code could have bugs), impermanent loss (price divergence in LP positions reduces value relative to just holding), liquidation risk (leveraged positions can be liquidated in volatile markets), token inflation risk (high APY farms often pay in tokens that lose value as supply increases), and protocol governance risk. High APYs are almost always a signal of high risk — there is no free yield in crypto.