Risks Of Yield Farming: Why High APR Can Still Mean Losses

1. What Is Yield Farming?

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• Yield Farming is providing liquidity to DeFi protocols to earn returns via trading fees and token rewards.

2. Risks In Yield Farming

2.1. Smart Contract Hacks (Unintentional)

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• Bugs or security holes in smart contracts can be exploited by attackers, leading to asset theft.

2.2. Rug Pulls (Intentional)

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• Developers may drain all liquidity and disappear, causing providers to lose funds.

2.3. Impermanent Loss

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• Temporary loss when token pair volatility causes mismatched values. Greater volatility increases the risk.

• Some platforms mitigate it via unbalanced pools (e.g., 95/5, 80/20, 50/50), though rewards may be lower.

2.4. Liquidation Risk

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• Using collateral in DeFi may result in liquidation during extreme market moves, affecting farming positions.

3. How To Mitigate Farming Risks

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• Farm token pairs with correlated price movements to reduce impermanent loss. 

• Farm stablecoin pools—they offer lower risk with typically smaller yields.

• Hold LP positions during price dips to avoid crystallizing temporary losses .

• Avoid farming during high volatility periods to minimize exposure .