The tl;dr on Yield Farming.
Krishang Nadgauda / June 28, 2021
3 min read
Our farm - pickle.finance
You're a yield farmer. You have a share in the pSLP yvBOOST / ETH farm with 10 units of shares. You open your dashboard and look at some metrics:
- Locked: 10 units
- $PICKLE earnings: x
Over time, you notice your $PICKLE earnings go up. You wait for a few days and then exit the farm, unlocking your assets from the farm in the process. You receive 10 units of pSLP yvBOOST / ETH tokens and some amount of $PICKLE tokens.
Here's what just happened — you were rewarded some dollar value $x (the $PICKLE earnings) for depositing away your assets ( pSLP yvBOOST / ETH tokens) in a smart contract (the farm) for some amount of time.
Where did the dollar value of your rewards come from?
To avoid any confusion that comes with the elaborate name pSLP yvBOOST / ETH, let's refer to those tokens as pTokens.
These pTokens are a kind of LP token representing some liquidity you provided to the pickle.finance app (this fact is denoted by the prefix p to the token name). You can redeem the underlying assets represented by your particular pTokens, in exchange for those pTokens. For instance, in your case, the underlying asset represented by your pTokens (i.e. pSLP yvBOOST / ETH tokens) is SLP yvBOOST / ETH tokens.
A DeFi app like pickle.finance has incentives to discourage liquidity providers from removing their liquidity from its platform i.e. exchanging the pTokens to get back the underlying asset. DeFi apps work most efficiently when they're handling a large amount of capital, and derive legitimacy from growing a user base committed to the apps' long term success.
So, to discourage liquidity providers from removing their liquidity from the platform, the platform rewards its liquidity providers to lock their LP tokens into the platform. Locking one's LP tokens in the platform represents some long term commitment to the project. Moreover, from a UX standpoint, it makes the act of removing one's provided liquidity from the platform a two step process — 1) unlock, and then 2) withdraw.
The platform rewards the liquidity providers who have locked their LP tokens, in the platform's own native token — in the case painted above, that's $PICKLE. The longer you lock your assets for, the greater the amount of rewards i.e. $PICKLE you accumulate.
Great — you were rewarded some $PICKLE for locking your pTokens in the platform for some time. But where does $PICKLE derive it's dollar value from? Generally, the platform creates a (reward token) / ETH liquidity pool on a decentralized exchange. Part of the profits generated by the platform's finance-doings are then directed towards this liquidity pool, adding value to each unit of the native platform token.
That's pretty much it! You just farmed some $PICKLE. The act of 1) providing liquidity to some arm of the platform, 2) locking your LP tokens into the platform and then, 3) as a result, accumulating rewards in the platform's native token — this is yield farming.