Yield Farming & Liquidity Mining

Introduction

What Is Yield Farming?

Yield farming – also known as liquidity mining – is one of the most popular ways to earn passive income with cryptocurrency in decentralized finance (DeFi). In simple terms, it involves deploying your crypto assets into DeFi protocols (like decentralized exchanges or lending platforms) to earn rewards, often at much higher rates than traditional banking. These rewards typically come from fees and incentive tokens distributed by the protocol. Yield farming and liquidity mining are central to passive income in DeFi because they incentivize users to provide liquidity, which in turn fuels DeFi services like trading and lending. (Centralized crypto platforms also offer yield products, but here we focus on DeFi strategies – see our comparison with CeFi later.) It’s now 2025, and many investors are searching for the best yield farms 2025 has to offer – but before chasing high returns, it’s critical to understand how yield farming works and the risks involved. This guide explains DeFi yield farming and liquidity mining from the ground up, in a beginner-friendly way, and provides an evergreen reference to all major aspects of DeFi-based yield strategies.

Yield farming refers to strategically moving and staking crypto assets in various DeFi platforms to generate high yields, often paid in new token rewards. Liquidity mining is closely related – many use the terms interchangeably. Both involve depositing tokens into smart contract liquidity pools to earn rewards. Liquidity mining focuses on providing assets to a pool for the platform’s token, while yield farming is broader, often hopping between platforms for optimal yields.

Origins: Yield farming exploded in “DeFi Summer” 2020, sparked by Compound’s COMP token rewards. Protocols like Uniswap and SushiSwap followed, distributing tokens to liquidity providers. This created a new passive income avenue: deposit tokens into pools or contracts, and earn high APYs plus governance tokens.

In summary, yield farming = liquidity mining in practice: lock crypto in DeFi for yield (interest + rewards). It powers many DeFi passive income strategies. Next, the mechanics.

Introduction

How Yield Farming Works

Yield farming uses smart contracts to reward liquidity providers. Here’s a detailed breakdown:

• Liquidity Provision: Deposit into a DEX pool (e.g., Uniswap ETH/USDC) or lending protocol (e.g., Compound) to become an LP. This supplies the liquidity traders or borrowers need, starting your earning process. Your contribution helps the protocol function smoothly, like fueling a marketplace.
• LP Tokens: Receive LP tokens as a receipt, representing your share and fees. These tokens track your contribution and let you withdraw proportional assets plus accrued fees. They’re essential for claiming rewards in farms.
• Staking for Rewards: Stake LP tokens in a farm (e.g., SushiSwap’s MasterChef) for extra tokens beyond fees. Farms are incentive programs to boost liquidity, distributing protocol tokens to stakers. This step turns basic liquidity providing into full yield farming.
• Incentives and Returns: Earn fees + reward tokens; APYs can hit triple digits, but fluctuate with demand. Compound by reinvesting for exponential growth, or swap rewards for profit. Yields combine fees from usage and tokens for participation.
• Vs. Holding: Puts idle crypto to work, earning on-chain while protocols gain liquidity. Unlike holding, it generates income during flat markets, turning passive assets active.

Example: Provide $1,000 ETH/$1,000 USDC to a pool, stake LP in a farm for 20% fee APY + 50% in tokens – potential 70% total, but with risks like price volatility.