The popularity of Decentralized Finance is without a doubt linked to the new mechanisms it enables for generating yields and other forms of earning not available in legacy financial systems. Prior to starting your trading journey -you need to learn the risks associated with yield farming. The MeowSwap team is committed to giving you the best DeFi experience possible — so here in this short publication, our team would like to provide some useful tips and information on DeFi’s inherent risks.
We can not offer financial advice, but we can help you navigate the submerged rocks in the deep sea of DeFi.
Essential DeFi terminology and risks to remember
Yield farming is one of the core concepts of DeFi; In essence, it is lending or staking a cryptocurrency to get rewards in the form of transaction fees or interest - the principle is very similar to the idea of earning interest from a deposit in a traditional savings account.
However, DeFi yield farming is slightly more complicated; especially for the beginner, so we will highlight the possible downsides you should keep in mind in this overview.
There are numerous decentralized exchanges now in the crypto space, allowing you to earn income by yield farming. However, each platform offers its own conditions for staking and the rewards you can earn by participating. So rule number one — explore and understand the specific rules of the service you are using.
When making decisions on allocating funds to a liquidity pool, which is known as becoming a ‘Liquidity Provider’, you need to keep in mind the following risks:
- The volatility of crypto assets and especially the volatility of token prices may lead to losses in relative value when yield farming. There is a particular term - ‘impermanent loss’ for the possible consequences of DeFi staking. Impermanent loss occurs when the price of your tokens when you withdraw your liquidity position is different from what it was when they were initially deposited into the pool. This is called an ‘impermanent’ loss because the price divergence between the assets in the pool may eventually decrease - if this happens, the effects of the impermanent loss are mitigated. Please note that the reverse is not guaranteed. An impermanent loss is also called a divergence loss.
- Security is a necessity - as we all know, smart contracts might have vulnerabilities, bugs or simply be written poorly. In this regard, please pay attention to whether the DEX holds an audit report from a reputable organization and if possible, how good the team’s technical expertise is through examining previous projects or personal profiles. We also advise you to check which software products are available on your chosen DEX — reputable,established DeFi exchanges usually aim for the best partnerships and software available on the market. Check for example; which wallets are integrated into the exchange and examine any strong, symbiotic partnerships they may have with other projects. Finally, if in doubt — ask them! send your questions to the tech support or other communication channels of the exchange; if they can’t answer questions they are doing something wrong!
As in any other investment activity, the exact returns generated through staking or yield-farming can not be predicted entirely as this activity is affected by many factors including the volume of the assets being traded and the previously mentioned concept of ‘impermanent loss’. So when investing in any assets, please be careful and do your own research first.
The risks of participating in DeFi protocols and their associated yield-farming mechanisms can be minimized through a diversified portfolio and other simple methods including backing up your recovery phase securely, using stable coins for deposits, amongst others.
Trading and yield farming are great ways of earning, and the MeowSwap team’s goal is to deliver the smooth and rewarding experience of crypto investing - whilst minimizing risk as far as possible. In this short article, we have introduced some major points of security you need to consider before starting your trading and yield-farming journey. We will continue sharing some insights on different trading and risk mitigation strategies, so you can enrich your knowledge and reduce your risk profile in this field.
Stay safe and happy trading!
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