Sometimes known as liquidity mining, yield farming is a means of generating rewards through cryptocurrency assets. Simply put, yield farming means being rewarded for investing cryptocurrencies.
Yield farming is similar to staking, in some way. However, it involves a whole lot more complexities. Most times, it functions with liquidity providers (LP) as users who fund liquidity pools.
A liquidity pool is fundamentally a smart contract containing funds. LPs receive rewards in return for funding liquidity pools. These rewards may result from fees generated by the principal DeFi platform, or any other source.
The rewards from some liquidity pools are paid in several tokens. These may then be deposited to some other liquidity pools to gain their respective rewards, and the like. It is already quite clear to see the complexity of the emerging strategies. In any case, the fundamental idea is that an LP funds a liquidity pool and, in return, earns rewards.
Typically, yield farming is done on Ethereum with the use of ERC-20 tokens, which are similar also to the rewards. However, this is subject to change in future. The reason being that, at the moment most of this process happens in the Ethereum space. Yet, advancements such as cross-chain bridges and others may later permit DeFi applications becoming blockchain-agonistic. What this means is that they will be able to operate other smart contract enabled blockchains.
Yield farmers will normally have their funds frequently moved around between various protocols in a search for higher rewards. Therefore, other financial incentives may be provided by DeFi platforms to draw more capital. Similar to centralized exchanges, more liquidity tends to be attracted all the same.