Today’s session will help you gain some serious knowledge about Yield Farming. Specifically, understanding what ‘Yield Farming/Liquidity Mining’ is, how you engage with Liquidity Pools on Yield Farming platforms, and lastly, understanding some of the specifics on the Trader Joe Platform.

Yield Farming is essentially the process of generating interest, from your tokens. This can be done in a number of ways. The context of Yield Farming in this session will strictly refer to Liquidity Mining on Trader Joe, which is the process where users can earn passive income by depositing tokens into a smart contract-based Liquidity Pool. Users on Trader Joe can then also deposit their tokens into a Farm, to generate an additional source of yield.

A liquidity pool is simply a basket that traders interact with to trade between the assets. A Pool will only consist of two assets, and these can be anything, such as $JOE and $AVAX. For any trade to be possible, there needs to be some $JOE and $AVAX in the Pool. This is taken care of by liquidity providers, who deposit the tokens into the Pool.

Liquidity pools use an automated market maker (AMM) algorithm that makes sure that the product of the quantities of the two supplied tokens always remains the same. On top of that, because of the algorithm, a pool can always provide liquidity, no matter how large a trade is. The main reason for this is that the algorithm asymptotically increases the price of the token as the desired quantity increases.

When liquidity is supplied to a pool, the liquidity provider (LP) receives special tokens called an LP token or (JLP Token: Joe Liquidity Pool) in proportion to how much liquidity they have supplied to the pool. When a trade is facilitated by the pool a 0.25% fee is proportionally distributed amongst all the LP token holders. The Trading Fees are added to the pool and accrue in real-time, Trading Fees are claimed by withdrawing your liquidity.

TVL is the aggregate liquidity in all liquidity pools on a platform. The more value that is locked, potentially highlights that more users are yield farming on the platform. TVL is therefore associated as an effective metric to compare the market share of different DeFi platforms.

Interest earned in the form of APR (Annual Percentage Rate) refers to the amount of profit a user may gain from deploying capital to a farming, lending or liquidity pool. In essence, it’s an estimation of potential, future profits over a one-year period. Reassessed every 24 hours, high APR’s are often unsustainable over time and prone to recalibration, unless the pool maintains its demand. There are a number of elements that can impact a pool’s APR, including popularity, liquidity, and incentivization.

The ‘pool weight’ is a representation of the amount of rewards a particular farm will receive. This is expressed as a ratio taken from the sum of all of the multipliers divided by the multiplier of a given pool.

Percentage Pool Weight: (Pool Weight / Sum of all Pool Weights) * 100

If all the pool weight multipliers on Trader Joe add up to 500X, then a 30X pool weight will receive 6% yield as a reward. Simply put, if a pool weight is set at 1X then that pool will receive 1 reward per block.

The higher the pool weight, the higher the APR. The Trader Joe team adjusts pool weights in order to incentivize the provision of liquidity to a particular pool. This means that a pool with high liquidity, which would usually have a lower APR, can be stimulated to produce a higher APR by increasing the pool weight.

In this example, the liquidity of both pools are almost identical, however, their APRs differ considerably. Usually, the more liquidity in a pool, the lower the APR, however in this instance the pool weight of USDC-AVAX (3X) is higher than JOE-AVAX (2X), resulting in a more favorable APR.