Yield farming refers to the practice of deploying crypto assets into DeFi protocols to earn rewards, often in the form of additional tokens. It emerged as a key driver of DeFi growth, offering returns far exceeding traditional finance.
Basic yield farming involves providing liquidity to an AMM and earning a share of trading fees plus liquidity mining rewards. More advanced strategies involve looping: depositing an asset as collateral, borrowing against it, and redeploying the borrowed asset to earn additional yield. This amplifies returns but also magnifies risk.
Risks include smart contract exploits, impermanent loss, liquidation risk when borrowing, and the potential depreciation of reward tokens. Prudent yield farmers assess protocol security (audits, bug bounties, TVL history) and diversify across multiple protocols to manage risk.