Yield farming, or liquidity mining, is a method of earning rewards as a result of providing tokens for liquidity.
For simplicity’s sake, farming can be likened to staking, but there are a few key differences between the two practices.
Farming is done by Liquidity Providers, who are users that lock their tokens in liquidity pools.
In turn, Liquidity Pools are smart contracts (Vaults), in which a certain number of tokens are located.
In exchange for locking in liquidity to a certain pool, providers receive rewards. One of the most important distinctions between farming and staking is the heightened risk inherent.
First and foremost, we are referring to the risk of Impermanent loss. Impermanent loss can occur as a result of price volatility for one or both of the tokens in a farming pool.
The higher the volatility is for one token relative to the other, the higher the chances will be of impermanent loss occurring.
From this, it stands to reason that the most stable form of earning in Farming Pools comes from the stablecoin pools.
We highly recommend that anyone looking to become a liquidity provider familiarize themselves with the risks of Impermanent loss. This will help you make the most out of farming and prevent you from running into any unpleasant surprises.
There are also IL calculators that you can use to help in the decision-making process, like this one.