Yield farming returns in DeFi can appear extremely high, but they usually come from liquidity provider fees, token incentives, compounding calculations, and short-term market imbalances rather than a permanently sustainable source of income.
Yield farming is connected to automated market making. In a decentralized exchange, users need to swap one cryptocurrency for another without relying on a traditional buyer and seller matching system. Liquidity pools solve this by holding pairs of tokens that allow swaps to happen quickly.
When someone yield farms, they contribute token pairs to a liquidity pool. In return, they may receive:
- liquidity provider fees;
- additional reward tokens;
- possible compounding returns;
- exposure to changes in the value of the tokens supplied.
The basic economic function is similar to currency exchange. If someone exchanges US dollars for euros, there is a spread or fee. In DeFi, liquidity providers can earn fees for enabling token swaps.
Where the returns come from
Yield farming returns can come from several sources.
The first source is the transaction fee paid by users who swap tokens. On Ethereum, users also pay gas fees to run the network, but liquidity providers may receive a separate fee for supplying the pool.
The amount earned depends on:
- transaction volume;
- total liquidity in the pool;
- the liquidity provider fee;
- how often the deposited capital is used;
- extra token rewards offered by the protocol.
If many people are trading through a pool and only a few people are providing liquidity, returns can be high because each liquidity provider’s capital is used frequently.
If many people provide liquidity but trading volume is low, returns fall.
Why APYs can look absurd
Some yield farming platforms show extremely high APYs.
One example mentioned is an APY of 11 billion percent on Beefy Finance.
This does not mean a person will actually earn 11 billion percent over a year. APY is calculated using compounding, often per block. A short-term daily return can produce a mathematically huge annualized number if compounded continuously.
For example, a return of around 5% per day can become an enormous annualized APY when compounded.
But that return is unlikely to continue.
High returns usually fall quickly because:
- new liquidity enters the pool;
- rewards are diluted among more participants;
- transaction volume may not remain high;
- reward token prices can fall;
- early incentives may be reduced.
The transcript mentions clients previously earning around 14% per day for a short period on meaningful capital, but such returns are treated as temporary rather than stable.
Liquidity imbalance can create high returns
A pool can produce high short-term returns when transaction volume is high and available liquidity is low.
For example, if the liquidity provider fee is 0.1%, a provider would need their capital reused around 50 times per day to generate around 5% daily return, ignoring exact compounding effects.
This can happen in small or new pools where there is high trading demand but little liquidity.
However, once people notice the high return, more liquidity usually enters the pool. That dilutes returns and pushes yields down toward a lower equilibrium.
Reward tokens and incentive farming
The second major source of high yield is token incentives.
New projects often need liquidity so that people can buy and sell their token. To attract liquidity providers, they may distribute additional reward tokens.
This can make APY appear extremely high, especially if:
- reward token emissions are large;
- the reward token price rises;
- few people are farming the pool;
- demand for the token increases;
- early liquidity is scarce.
This can create a feedback loop.
High rewards attract buyers. Buyers push up the token price. A higher token price increases the value of reward emissions, which pushes the displayed APY higher.
But the reverse can also happen. When returns fall, farmers may sell the reward tokens they earned. If many people exit at once, the token price can crash.
This is why very high APYs are often short-lived.
Inflation risk in reward tokens
High reward emissions can be inflationary.
If a protocol gives large amounts of tokens to liquidity providers every day, the supply of that token increases. Unless demand remains strong, the price may fall.
A protocol offering high daily token rewards may attract capital quickly, but it may also create pressure on the token price once farmers start selling rewards.
The transcript distinguishes between very high, unstable returns and lower but more stable returns.
For example, staking CAKE at around 300% for several months is described as high but more stable than extreme multi-million or billion-percent APYs.
Returns compress over time
Yield farming returns usually decrease.
One example mentioned is FILDA, where putting FILDA into a DAO pool produced around 810% when funds were deposited. The transcript notes that such returns tend to fall over time and may compress toward much lower levels.
This does not necessarily mean the opportunity is useless. The argument is that a yield can be worth using while it is available, then abandoned when the return becomes unattractive.
The comparison given is a stock that rises rapidly. The fact that the rate of increase is not sustainable does not mean a person could not benefit during the period when it was rising.
Main risks in yield farming
Yield farming is not risk-free.
Risks mentioned include:
- smart contract risk;
- hacks;
- rug pulls;
- infinite minting;
- token price crashes;
- reward token inflation;
- liquidity pool losses;
- unsustainable APYs;
- rapid dilution as more farmers enter.
A rug pull can occur when a project is designed or manipulated so that users lose funds. Infinite minting can allow excessive token creation, which can destroy value.
Smart contract risk means that the code itself may contain vulnerabilities that attackers can exploit.
These risks apply even if the yield appears to have a rational source.
Sustainable versus temporary returns
The transcript argues that “not sustainable” is not always the right way to evaluate yield farming.
Some opportunities are temporary by design. A farmer may use them while returns are high, then move capital elsewhere when returns drop.
The important distinction is between:
- a rational but temporary incentive;
- a pool with real transaction fees;
- a reward program that will dilute;
- a scam or structurally dangerous pool.
A high APY does not automatically mean a Ponzi scheme, but it also does not mean the return is safe or durable.
Practical decision criteria
Before entering a yield farm, a user should assess:
- where the return comes from;
- whether it is fee-based or reward-token-based;
- how much liquidity is already in the pool;
- how much trading volume the pool has;
- whether reward emissions are sustainable;
- whether the reward token is likely to be sold heavily;
- whether the protocol has smart contract risk;
- whether there is rug pull or infinite mint risk;
- how quickly capital can exit;
- whether the user already wants to hold the underlying token.
The transcript suggests that yield farming may make more sense when a person already holds the token and wants to earn additional return while holding it.
Practical takeaway
Yield farming returns come from real mechanisms, including liquidity provider fees and incentive tokens, but the highest APYs are usually temporary.
Large returns can happen when liquidity is scarce, trading volume is high, or reward token incentives are aggressive. Those returns often fall as more capital enters the pool or as reward token prices drop.
The practical approach is to understand the source of the yield, recognize that extreme APYs will likely compress, and treat yield farming as an active strategy with smart contract, token, liquidity, and rug pull risks.
