This article is about yield farming, which refers to a decentralized finance strategy of providing liquidity and seeking associated rewards in the form of transpired-transaction fees. We explain and demystify yield farming and quantify transaction costs, returns, and risks using on-chain data from major decentralized exchanges. We provide a mathematical framework that resembles a representative agent’s yield farming process and features stochastic returns, impermanent loss as a source of risk, and transaction costs. Calibrated to historical market data, the model’s output opens a discussion on the economic insights that underlie yield farming and reveals the trade-off between future benefits and the associated transaction costs.

A preprint is available at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=4422213