If you came to DeFi through the promise of mind-boggling annual percentage returns (APRs), yield farming is where those numbers come from.

I pooled my tokens. Isn’t that yield farming?

No, not yet. Both liquidity provisioning and yield farming generate income, but one is paid out as fees based on trades, while the other is a reward given by the trading platform in exchange for locking (or “staking”) your liquidity with them.

Whereas the trading fees from depositing liquidity are paid back as a fractional percent of the underlying tokens, the rewards from yield farming are often given as a separate token related to the platform. Since you are earning new tokens simply for staking your LP tokens, yield farming is also sometimes referred to as “liquidity mining.”

You can think of LP and farms as nesting dolls for your tokens, which let you double dip on your investment (there is actually a third layer possible, which involves something called “vaults,” but that is for another day).

On ElkDex, ELK is distributed as a farming token in exchange for staking your LP tokens. Since ElkDex only supports farms for liquidity pairs that include the ELK token, by farming on ElkDex, you are actually earning ELK tokens in two ways: as fees (given along with an equal amount of the paired token) and as farming rewards.

Isn’t that free money? What’s the catch?

Sort of. But, yes indeed, there are some important caveats. First, it’s useful to understand why yield farming exists — in other words, why do DeFi platforms offer additional tokens in exchange for locking your LP tokens?

The short answer is that it provides an incentive for you to deposit your valuable tokens into their pools instead of those offered by competitors.

Liquidity providers typically earn a fraction of trade fees, but DEXs also generally take a cut for themselves too. (And here is a good time to note that all trading fees on ElkDex are given to our liquidity providers! Elk does not take a cut.) For DEX operators, it’s a volume game: the more volume, the more profits they generate.

If two platforms are offering the same cut of trading fees (say, 0.3%), giving out an additional token can be a powerful incentive to attract and maintain precious liquidity.

Hungry for APR!!

For various reasons, yields are often much higher just after a project has launched, which has recently given rise to a phenomenon known as “yield chasing,” where hungry investors will move their tokens en masse to a new project in order to capture the early returns. This dynamic, in turn, has resulted in a slew of new questionable projects cropping up that promise high yields but offer few details about their plans or operations.

As with anything in life, if something seems too good to be true, it probably is, and it is important to do your due diligence before deciding to enter a yield farm.

Sometimes, the farming tokens have no actual utility, meaning that their value is (through a circular logic) purely a function of the platform’s popularity. In fact, there are some platforms that do not have their own trading features but instead take deposits of LP tokens from DEXs. Such platforms, generating tokens through farming is their sole reason for existing.

Usually though, platforms will create some sort of utility for their token. Often, this comes in the form of “governance tokens,” which means that owning the tokens also gives you voting rights on the platform, which are weighted proportionally relative to the amount of tokens you own.

Whether it is governance or some other benefit, ideally there will be some added utility or use case to justify the token’s existence, or it is highly unlikely that it will maintain its value over time.

The ELK token, which is distributed as reward on ElkDex farms, is a governance token, meaning that token holders are able to exercise influence over the future direction of the project. But it also comes with multiple additional use cases, such as running a node on ElkNet.

Emissions

The post Elk Academy Lesson #2: Yield Farming appeared first on Elk.

Whether your goal is maximizing yields, generating passive income, diversifying your traditional portfolio, or just being part of a global financial revolution, these articles will cover the core concepts so you can invest your money with confidence.

Elk Academy Lesson #1: How to become a Liquidity Provider, for Fun…and Profit!

What is a Liquidity Provision?

A liquidity provision (often abbreviated as LP), is an allocation of assets pooled on a decentralized exchange (DEX) that runs via an automated market maker (AMM) protocol, and which allows for trading of those assets.

Okay, right. But really, what is LP?

In short, LP is the backbone of DeFi and a key part of what makes it “decentralized.” In traditional financial markets, banks and large institutions act as liquidity providers (also called “liquidity provisioners”), supplying a pool of capital to allow for trading on an exchange.

Basically, if you want to create a market for trading apples and bananas, first you need to gather together a lot of apples and bananas so you don’t run out of apples if there happens to be a run on bananas.

In exchange for establishing this pool, liquidity providers typically take a small fee for every transaction, which is how they generate profit. The Great Big Idea of DeFi is that you (or rather, we) become the market maker.

If you provide liquidity on ElkDex, you will earn a 0.3% fee on each trade, proportional to your share of the pool.

People use the shorthand “LP” interchangeably to describe the liquidity provider (the farmer), their liquidity provision (the fruit), or the liquidity pool (the basket) it goes into.

Liquidity refers to the assets generally, but it can also be used to describe how easily one asset can be exchanged for another without causing large price swings in the price of the underlying assets.

Again, think of price as a function of supply and demand: if bananas become scarce, they become more valuable relative to apples. Fewer bananas means the price shift will be more severe each time one is removed.

This shift in price is referred to as slippage, or sometimes price impact (PI). A pool with greater liquidity (i.e. more fruit) can handle more trades with less slippage, so typically the more liquidity in a pool, the better.

On most DEXes, including ElkDex, providing liquidity requires depositing an equal value amount of a pair of two tokens into a pool, which allows other users to swap (i.e. trade) those tokens. When you add liquidity to an existing pool, the AMM will automatically determine the price ratio based on the current value of each token.

What are LP tokens?

When you stake liquidity by depositing your paired tokens, it enters a pool, which is a smart contract that includes the tokens of everyone else who has deposited. LP tokens are essentially a receipt of your deposit, which is used to keep track of how much you are owed when you decide to unstake (remove) your liquidity.

It’s important to keep in mind that LP tokens are placeholders and therefore cannot be traded like regular tokens. Since they are just used for record keeping, exchanges typically do not display or track the value of LP tokens (this would be like asking “What’s the value of an apple and a banana?”).

For this same reason, you may encounter LP tokens with odd looking values, such as 0.00000000567. They are, however, useful for yield farming, which we will tackle in the next lesson.

LP tokens typically carry initials that indicate their source. On ElkDex, for example, all LP tokens are designated ELP, which just stands for Elk LP.

Can I swap two tokens if there is no liquidity available?

Maybe. There needs to be a path to connect two pairs. On ElkDex, all of the liquidity pools use the $ELK token as one of the base pairs (there’s a very important reason for this, which will be explained in a later article!).

But for now, let’s say you want to trade your Apples ($A) for some Bananas ($B). On ElkDex, there will likely be an ELK-A pool and an ELK-B pool. You can therefore swap those two assets using ELK as a go-between, with a path of A>ELK>B.

Sometimes there can be longer paths with three or even four tokens depending on what pairs are available on the DEX. Both ElkDex and ElkNet (which handles cross-chain swaps) are optimized with a smart router, which finds the most efficient path between the two tokens in order to minimize the amount of slippage.

Can I create LP pools by pairing any two tokens?

Yes, you can! But remember, you only earn fees on trades, so if no one is interested in trading your pair, you won’t earn anything. Pairs with higher trade volume generate more fees. If you do decide to create a new pool, it will also be up to you to set the initial price ratio between the two tokens.

What are the risks of becoming a liquidity provider?

There is some risk of a bug or vulnerability in the underlying smart contracts that could expose them to hacks or exploits. For this reason, it is always good to see whether the contracts have been audited by a third-party security firm. (The contracts for ElkDex, which are based on Uniswap contracts, have been audited by HashEx).

But aside from an exploit, which is a relatively minor threat if you are using a reputable platform, the primary risk that liquidity providers face is something called impermanent loss (IL), which happens when the price of the two tokens in the pair diverge.

We will unpack this concept in an upcoming lesson, where we’ll also discuss one of Elk’s unique features, lmpermanent Loss Protection (ILP), which gives our liquidity providers insurance against impermanent loss.

Next time, however, we’ll talk about emissions and yield farming. Did you think you were already farming? Not yet. Yield farming lets you put your LP to work in order to earn tokens on top of trading fees. Double dip!

The post Elk Academy Lesson #01: Liquidity Basics appeared first on Elk.