How to DYOR: DeFi Farms Edition

DeFi farming can be very lucrative if executed properly, but it also comes with risks that you need to consider before participating. To mitigate these risks, a simple approach is to conduct your research (DYOR) before investing. This article outlines key information you should know when researching a DeFi protocol you want to farm.

Introduction to DeFi Farming

DeFi (decentralized finance) farming is a way of earning a return on your cryptocurrency by performing various activities, such as staking, lending, and borrowing, on specific decentralized applications. It is similar to traditional banking, but with no middlemen, and the returns can be significantly higher. However, DeFi farming is a relatively new and rapidly evolving space, with many risks that can result in significant losses for inexperienced investors.

Risk You Should Know

Smart Contract Risk

Smart Contract Risk refers to the potential for harm or loss due to issues related to the programming or execution of a smart contract. These risks can include coding errors, security vulnerabilities, and unforeseen circumstances that can lead to the unexpected or unintended behavior of the smart contract.

Scams

Scams are rampant in the cryptocurrency industry, and many people have lost a significant amount of money by investing in projects that they heard about from influencers. Because crypto is a highly speculative asset, traders often feel FOMO when a particular token or protocol is being promoted. This causes them to rush in to buying the asset or participating in the protocol, only to find out that it was a scam or rug pull.

Always be extra vigilant when CT influencers start promoting a token because they may be using their followers as exit liquidity.

Gas fees

There is also a risk of gas fees eating up your investment, which is associated with the specific chain you are using because yields differ per chain. Always take into consideration your capital, investment time frame, and token you are farming because paying high gas fees just to participate may not make it worth your time.

Impermanent Loss

Lastly, the most important risk to understand is impermanent loss. Impermanent loss occurs when the value of your LP decreases due to a decrease in the price of the token. This commonly seen in decentralized exchanges that require you to deposit a pair of assets that are equal in value, mostly in a form of an altcoin and a stablecoin.

However, it’s important to know that the loss is “impermanent” because you only lose it when you decide to take profit. You can simply wait it out till the token price is above what you entered the LP with to have positive gains on top of farming rewards.

If you want to learn more about Impermanent Loss please read this article.

Ways to DYOR

To mitigate these risks, it is essential to conduct your research before investing. Here are the key areas to focus on:

Security and audits: Look for projects that have undergone third-party security audits and have a bug bounty program in place. Check the project's GitHub repository for any known issues, and look for information about how the project manages key storage and access control.
Tokenomics: Examine the project's tokenomics, including its supply, distribution, and inflation rate. Look for projects with a fair and sustainable distribution model that incentivizes long-term participation.
Project Roadmap: Check the project's roadmap and milestones to understand its development trajectory. Look for projects that have a clear and realistic roadmap and are actively engaged with the community.
Team and backers: Examine the project's team and its advisors and investors. Look for experienced developers and advisors with a track record of success in the industry. Check their social media profiles and professional backgrounds to ensure they are genuine and trustworthy.

DeFi farming can be a lucrative investment, but it is also highly risky. To minimize your risks, it is essential to do your research and DYOR. Focus on security and audits, tokenomics, project roadmap, and team and backers when deciding to farm on a particular protocol. By identifying these key information, you can make informed investment decisions and protect your capital in this exciting but volatile space.