⚠️Risks

be careful anon, impermanent loss can be permanent

There are a vast number of risks associated with yield farming. Below, we've gone over some of the most prevalent:

Risk of Impermanent Loss

Impermanent loss risk is one of the biggest risks of yield farming.

When farming yields on your assets, you add liquidity in pairs of equivalent value; if you add one ETH in an ETH/USDC pair and 1ETH is 2000 USDC, you must add 1ETH and 2000 USDC. However, crypto is volatile and can affect the fiat value of your coins at the end of the day.

Suppose the value of ETH falls to 1000 USDC, the coins in the entire liquidity pool shift to make up for that. When you have a huge loss in any of the coins in the pool in such situations, you can end up with an impermanent loss where you get a lower value than what you put in when you withdraw your liquidity.

The profit from farming yields on your cryptocurrency assets sometimes make up for the loss, but it doesn’t always. Given the volatility of cryptocurrencies, you risk impermanent loss risk any time the value of a cryptocurrency drops. However, it only happens when the difference in value drops a lot.

Gas Fees Rise Unpredictably

Gas fees on Ethereum are high – this is one fact that no one can debate. This is a problem for DeFi yield farming, especially for investors with smaller funds; wealthier participants might not mind.

When a lot of people take advantage of a yield farming opportunity and lock a lot of cryptocurrency in DeFi, gas fees skyrocket. In 2020, this was a big issue where gas fees reached over 100x more than usual due to yield farming activities on Uniswap.

When such happens, those with fewer funds would realize it’s costly to withdraw their earnings and might end up losing money if they try. If they choose to leave the cryptocurrency in the pool, any other risks, such as impermanent loss and liquidation risks, can lead to a loss. Ethereum 2.0 with layer two scaling aims to solve this problem.

Strategic Risk

When doing yield farming, your strategy matters. You have to decide on what kind of pair to invest in. A hot pool today wouldn’t be hot in a few weeks from now.

Here’s the thing: if a pool provides 2000% returns which usually happens at launch, in a few weeks, that can drop to 300% because more money would have been pooled in by then. People would find out about that pool and invest, and as more people invest, the returns would reduce.

Although yield farming can be passive, you need to monitor your investment periodically and keep up with crypto market news, so you can pull out of a pool and invest in a better one when you need to.

You also look at the market’s volatility as that can affect your capital and returns. If you weren’t sure about a coin but invested only because of the high returns and the value is falling fast, you might decide to pool your investments in another pool.

Yield farming can be long term, so you shouldn’t have to jump from pool to pool. Strategize wisely, and you will enjoy the returns from your crypto assets.