Yield Farming Explained

Where does the money come from?

In traditional finance, if a bank offers you 4% on your savings, they are taking your money, lending it out for 7%, and keeping the difference.

In DeFi, if you see a 10% yield, you should always ask: Where is this money coming from? If you cannot answer that question, you are probably the source of the money.

The two types of yield

DeFi yields generally fall into two categories: real yield and inflationary yield.

1. Real Yield

This is yield generated by actual economic activity.

You deposit USDC into Aave. A borrower takes that USDC and pays 5% interest. You get 4% (the protocol keeps 1%).
You provide ETH/USDC liquidity on Uniswap. Traders swap back and forth, paying a 0.3% fee on every trade. Those fees go directly to you.

Real yield is sustainable because someone is actively paying for a service. Typical returns are 2% to 15% APY, depending on market demand.

2. Inflationary Yield (Liquidity Mining)

Imagine a new protocol launches: SuperDEX. It has zero users and zero liquidity. To attract money, SuperDEX announces: "If you deposit your crypto here, we will give you our new SUPER token as a reward, offering 1,000% APY!"

This is liquidity mining. Yield farmers rush in, deposit funds, and receive SUPER tokens. The high APY is entirely subsidized by the protocol printing its own token out of thin air.

What usually happens? The farmers take the SUPER tokens they earned and immediately sell them on the market for stablecoins. The massive sell pressure crashes the price of the SUPER token. The 1,000% APY quickly drops to 2%, and the farmers leave for the next protocol.

Strategies and Aggregators

A "yield farmer" is someone who constantly moves their capital between protocols to chase the highest return. Doing this manually costs time and gas fees.

Yield Aggregators (like Yearn Finance) automate this. You deposit your stablecoins into a Yearn Vault. The vault's smart contract automatically moves the pooled funds across Aave, Curve, and other protocols to find the best yield. Because the funds are pooled, the gas costs are shared among all depositors, making it highly efficient.

Key takeaways

Never invest in a yield without understanding exactly where the money comes from.
Real yield comes from trading fees, borrowing interest, and network staking.
Inflationary yield comes from protocols printing their own tokens to incentivize deposits. It is rarely sustainable.
High APYs (over 20%) almost always involve significant token inflation or extreme risk.