The decentralized finance space has grown exponentially over the last few months, to the point where more than $9 billion worth of crypto assets were locked in its protocols before crypto prices started dropping. The space had a little over $500 million locked in back in September 2019.
This exponential growth in the last few months appears to be mainly related to a yield farming trend that started when lending protocol Compound began distributing its COMP governance token to users who interacted with the protocol.
Put simply, yield farming — or liquidity mining — allows DeFi users to generate rewards with their cryptocurrency holdings by interacting with protocols that distribute governance tokens. Farming yield can be a profitable venture on its own, but the tokens being farmed often see their price surge as well.
One of many examples of this is YFI, the governance token of Yearn.finance, a site that helps users find the best yields in DeFi protocols. Over the last 30 days, YFI is up more than 400%.
The risks of chasing short-term gains
Yield farming isn’t simple, however, and rewards rarely go up in a straight line. It’s also not a practice that’s suitable for all crypto holders since it generally requires holders to pledge large amounts of capital in order to earn more rewards. Moreover, in the decentralized finance space, there are various risks that aren’t immediately clear.
One risk associated with yield farming that most people seem to neglect is the very nature of smart contracts. Popular DeFi protocols are developed by small teams with limited resources, which can increase the risk of smart contract bugs and vulnerabilities. Even well-known audited protocols have been hacked.
The smart contract risk is very real and could end up costing a lot of people money. One famous case is that of Yam Finance (YAM), a DeFi project that saw users lock in over $500 million worth of crypto assets on it before a bug that was discovered made it impossible for the…