Yield farming is a strategy used to generate passive income by providing liquidity. It is the practice of staking or locking up cryptocurrencies in return for rewards.
Users can earn either fixed or variable interest by investing crypto in a DeFi market. The idea is to lock up funds in a liquidity pool – smart contracts that contain funds. The liquidity pools power the marketplace where users can exchange, borrow, or lend tokens. Once you’ve added your funds to a pool, you officially become a liquidity provider.
Typically, the yield farming returns are calculated as annualized. You will see that the most common metric used to measure these returns are Annual Percentage Rate (APR) and Annual Percentage Yield (APY). APY usually gives you compounded returns, aka the profits generated are directly reinvested to produce more returns.
*Do keep in mind that all APR and APY percentages are just estimations. These are never guaranteed.