Yield farming is a concept that has gained great popularity in recent years in the DeFi world. It’s an investment strategy with which token holders seek to obtain excellent returns for their money, investing and participating in different DeFi platforms, always with the intention of finding any financial advantage that allows them to maximize profits.

Without a doubt, this is a form of investing that can generate excellent returns if done correctly and has quickly gained a lot of momentum for its application on many platforms within the crypto ecosystem.

But what are the 4 types of yield farming and is yield farming halal?

Generally speaking, the 4 types of yield farming are as follows: 1) Liquidity Pools, 2) Lending and Borrowing, 3) Staking (proof of stake), and 4) Holding for a Redistribution Fee. As for if yield farming is halal, not all types of yield farming would be considered halal. It depends on the type of yield farming you participate in.

Let’s take a closer look at each of the 4 types of yield farming and let’s see which type of yield farming would be considered halal and if any of the 4 types of yield farming would be considered haram.

What is yield farming?

Yield farming is a formula by which investors try to obtain profits from the storage of cryptocurrencies. With this investment method we have two key factors to consider:

1. Liquidity provider (LP) – A user who brings cryptocurrencies to the market
2. Liquidity reserve (LR) – A smart contract that validates and manages the funds provided by the LP

Basically, in yield farming, LPs obtain rewards in exchange for providing liquidity through their funds, something similar to the interest paid by banks to those who keep money in them for a certain period of time. But one main difference is that in Islam, it is haram to collect bank interest since it is derived from usury, but with yield farming, some types of yield farming are halal. We’ll touch on this more later in this blog post.

How does yield farming work?

In a yield farming system, investors transfer or deposit assets into a smart contract providing liquidity. In exchange for this, the system will offer them a benefit for the immobilization of these assets.

This can be done through specialized platforms that facilitate the whole process, usually on Ethereum ERC-20 tokens, but since there is no single model or a single system to apply this formula, each platform usually applies its own rules, which can be modified from time to time.

What are the 4 types of yield farming?

Here is a list of the main methods of yield farming that you can find in the market. Of course, it is also possible to find some variations of these methods, but in general, they’re as follows:

1. Liquidity pools

A liquidity pool is perhaps the most common form of yield farming. As I already explained, this works with a smart contract that blocks tokens to ensure liquidity on a decentralized exchange platform. The users who provide these tokens are called liquidity providers.

The liquidity pool will hold two tokens in a smart contract to form a trading pair. Suppose there are tokens “A” and tokens “B”. Suppose also that the price of A can be equal to 100 B.

LPs must contribute the same value of A and B to the pool so that someone who deposits an A token will also have to add 100 B to the same contract. So when someone wants to exchange A for B, they can do it based on the funds deposited in the contract, instead of waiting for another user to appear who wants to do the opposite operation – as happens in crypto exchanges.

LPs are then incentivized for their contribution with different types of rewards, which usually are native tokens of the platform that provides the service.

What are the risks of liquidity pools?

Although this activity can be very profitable, it’s important to be aware of the risk of impermanent loss (IL). This means temporary losses of funds due to the high volatility of the trading pair; the higher the volatility, the higher the IL risk.

In this case, the losses are for less money at the time of withdrawal, which means that a liquidity provider can end up with a greater amount of the B token and slightly less of the A token or vice versa. However, IL can be compensated by trade commissions and other additional rewards earned by LPs.

2. Lending and borrowing

The idea behind a lending and borrowing mechanism is very simple: lenders provide funds to borrowers in exchange for a regular interest rate.

In the crypto world, lending and borrowing are carried out through different types of platforms that can be centralized or decentralized.

If we take this to the world of DeFi, both providers and borrowers interact in fully decentralized platforms in which they have total control over their money, thanks to the use of smart contracts that operate mainly on the Ethereum network.

The way this works is very simple: user X sends a certain amount of funds to a lending platform using a smart contract, which will then provide them with earnings in the form of interest, usually in the platform’s native token.

Such a smart contract then becomes a kind of intermediary available to other users of the platform who want to apply for a loan – the money contained in the smart contract. Subsequently, lenders can withdraw their earnings from the platform from time to time in the form of interest in native tokens.

As a general rule, for a user to be able to request a loan in native tokens, he must previously deposit in the form of a guarantee, an amount in another cryptocurrency, equal to or greater than the amount of the loan that he’s going to request.

What are the risks of lending and borrowing?

Although this financial activity is usually quite safe in the DeFi context, there are also a couple of aspects that need to be considered.

First, there is always the possibility that the smart contract used for the operation receives some type of manipulation. This is more likely in the cases of smart contracts provided by third parties.

On the other hand, borrowing APYs on some cryptocurrencies could suddenly go up for some reason, which could lead to the most careless users ending up paying more than expected.

3. Staking (proof of stake)

Staking within the universe of cryptocurrencies involves keeping a certain amount of funds in a wallet in order to obtain yield for keeping this crypto locked up or “staked” on a blockchain.

This action of holding funds in a crypto wallet, also known as staking, serves to support the security and operations of a blockchain network by validating transactions on the network. In return, they are able to generate yield, or rather, earn cryptocurrency, for providing such a service to the network.

This consensus system is known as Proof of Stake (PoS) and is based on the fact that to obtain consensus, users must demonstrate possession of the indicated funds.

The idea is that users block cryptos and from time to time, the network randomly assigns the right to one of them to validate the next block, the probability of being chosen is directly proportional to the amount of frozen funds held on the network.

In this system and unlike what happens in other consensus mechanisms – such as PoW in Bitcoin – the users who act as validators, don’t compete with each other using the computing power of their equipment, but instead, put up a share of assets to certify that they’ll validate transactions in an honest way.

What are the risks of staking?

In the case of staking, you have to consider the risk of keeping a high amount of funds locked on a blockchain for a long period of time. Remember that there can always be attacks on these platforms that end in the partial or total loss of the funds held, something that has already happened on many occasions.

In addition, in some cases, these funds are placed in the hands of third parties, which implies a risk if there is an internal theft attempt on the platform.

4. Holding for a redistribution fee

Some decentralized exchanges facilitate the buying and selling of different crypto assets between users, but they do so through a model called automated market making (AMM).

Users can add their inactive tokens to the liquidity pools available on the platform and earn passive income according to their contribution and at the same time, other members can exchange tokens from these liquidity pools – the profits go to the community of users.

In the case of SushiSwap for example, anyone can provide liquidity through its internal app. When they do, they’ll receive SLP tokens (SushiSwap Liquidity Provider tokens). For example, for a $SUSHI and $ETH pair, the user would receive SUSHI-ETH SLP tokens.

Any user can create a new liquidity pool simply by providing a new pair, and it’ll be the proportion of tokens that the user adds, which will set the price of this new liquidity pool.

Afterward, other users can trade any ERC-20 token and when transacting on SushiSwap Exchange, a fee of 0.3% will be charged and 0.25% of this trade will go back to the users that make up the LP group.

In exchange for maintaining liquidity in these groups, LPs are rewarded with these fees, in addition to a portion of the SUSHI minted daily on the platform. The best part is that users can claim their funds at any time.

What are the risks of holding?

As with any liquidity pool, there is a risk of suffering losses due to IL, but also that the borrowing APY goes up in price or that the platform suffers from theft of funds.

BONUS

5. Hodling

The term “hodling”, also known as “hold on for dear life” in the crypto world, is used to define those who simply hold onto their cryptocurrency as a long-term investment strategy without worrying about the rise and fall in the price of tokens.

This is not a form of yield farming in its most pure essence, but you can also see it that way for your convenience – especially if you don’t have experience with crypto finances.

Hodling is a strategy used by people who don’t have the skills or the time to perform other types of operations, so these people invest in well-established projects for long-term investment.

The objective of hodlers is that, over time, the value of the selected cryptocurrency will increase, so the most common strategy is to invest in the purchase of relatively new cryptocurrencies with very low prices so that, as the value of these assets increases, they can, insha’Allah, make a good profit on such an investment.

This form of “yield farming” has proven to be one of the strategies that has worked best for Bitcoin users.

For example, if you had invested $1,000 to acquire 1,000 BTC when the price was at $1 during 2011, at the time of publishing this blog post, you would have approximately $60 million in a period of only 10 years!

What are the risks of hodling?

HODLing won’t increase the number of cryptocurrencies you have in your hands. This means that you will only make a profit if the cryptocurrency increases in price in the long term. But remember that the opposite could also happen, with which you would lose money instead of increasing.

Is Yield Farming halal?

Is yield farming halal? When it comes to yield farming, staking, as in Proof of Stake, is generally considered halal, while the other 3 types of yield farming, liquidity pools, lending and borrowing, and yield from redistribution fees would be considered questionable or even haram.

Proof of Stake is generally considered halal as you are earning yield for providing security to the network. This is obviously assuming that the network itself is not dedicated or established for some haram type of activity.

Earning yield from liquidity pools could be halal so long as the pool itself is not being used for haram operations such as loaning money to others to earn interest on the loan. Muslims should strive to not purposely put themselves in situations where they are directly contributing to what is known to be haram.

When it comes to earning yield from lending and borrowing, many scholars would say that this is haram as the objective of most DeFi projects is to establish lending and borrowing contracts that will allow the lender to earn money from interest. However, this may change if lending and borrowing contracts are established under Islamic finance investment tools such as “Murabaha” or other sharia compliant guidelines.

And as for earning yield from redistribution fees, this could also be seen as halal since you are providing a service to the platform so long as the purpose of the platform or DEX is not a lending pool where the goal is to earn interest off of loaning money by way of crypto.

All of this is said by making the assumption that the cryptocurrency you are using for yield farming is already seen as halal by scholars.

Final words

We have now explored the most common types of yield farming strategies, acknowledging that there are many variations in them. If your intention is to enter the world of yield farming, you should first familiarize yourself with the operation of the different platforms that offer this form of investment making sure that they are in harmony with Islamic principles.

Take into account that if you don’t understand what you are doing, you’ll probably lose money. Remember that the most profitable yield farming strategies are also the most complex ones and are recommended for advanced users.

It is not just about buying crypto when Elon Musk makes a comment that boosts its price, but there is a whole range of possibilities to earn much more money out there in a halal way. You just have to be well prepared and do your research.

May Allah guide you to success, Ameen.

PLEASE KINDLY SHARE THIS ARTICLE IF YOU’VE FOUND BENEFIT IN IT

We all want our cryptocurrencies stored in a safe place where no one can access them, but we also want speed, low fees, and a variety of benefits and/or options when carrying out crypto trading, right?

Cryptocurrency exchanges emerged some time ago as a response to the needs of crypto users around the world, and they’ve evolved mainly into two types: Centralized Exchanges (CEX), and Decentralized Exchanges (DEX).

Each type has its pros and cons, and as the crypto world continues evolving, so do exchanges, and it can be quite difficult to discern which is the best choice for you among so many options available.

Insha’Allah we’ll explore the world of centralized and decentralized exchanges and learn about the differences between the two, the advantages and disadvantages of each, as well as provide a list of centralized and decentralized exchanges that are popular to use so that you can better decide what’s the best choice for you.

What is a cryptocurrency exchange?

A cryptocurrency exchange is an online platform that allows its registered users the trading of digital assets – whether crypto or fiat money – in a secure and efficient way.

The basic function of these platforms is to provide the necessary tools for users to carry out cryptocurrency trading in person-to-person (P2P) transactions.

Obviously, each exchange has its particular procedures, but in general, they all work in a similar way:

1. You sign up on the platform
Each platform will request some personal data from you, and while some exchanges ask for a large list of requirements, others will only ask for a username and email. Many exchanges may also apply “know your customer” (KYC) policies to verify the authenticity of the data you provided.

2. Fund your account
Once you’ve signed up, you can transfer money into your account whether in the form of other cryptos (Bitcoin, Ethereum, Litecoin, etc.) or fiat money (US Dollar, Malaysian Ringgit, Euro, etc.). Payment methods will vary according to the exchange, and while some will accept popular payment processors like PayPal, others won’t.

3. Perform transactions
You can then trade your currencies for another, trading from fiat to crypto or from crypto to crypto. The most popular currencies usually are Bitcoin, Ethereum, USD, and EUR.

4. Withdraw your money
You can finally withdraw the money you’ve invested, converting it to the currency you prefer. You can then withdraw to your bank account or another payment platform, depending on the exchange.

Let’s take a more in-depth look at the difference between CEX and DEX exchanges so you can better see the difference and how they work.

What is a centralized exchange or CEX?

A centralized exchange is a platform where each transaction goes through a central authority that controls all operations on the platform. The majority of exchanges today are of this type.

These exchanges usually make a profit by charging a commission for each transaction on their platform, but they may also have additional ways to generate income.

One important feature of CEX platforms is that they not only provide a means for trading, but they’re usually easy to use and many times, they also offer powerful analysis and security tools for your transactions.

On the other hand, you’ll find a greater level of security processes to follow in order to gain access to the platform, like “know your customer” (KYC) and Anti-Money Laundering (AML) policies.

What is a decentralized exchange or DEX?

In decentralized exchanges, transactions take place directly between two users. In this way, there is no need for intermediaries because the users are who establish the terms for negotiation.

You won’t find CEOs or employees here; since these platforms run based on blockchain technology, everything is controlled democratically among users.

To give you an example: in the case you want to buy a cryptocurrency like Dogecoin by paying with Bitcoin, you go to the platform and simply set an initial bid price. If someone agrees with that price, you pay with Bitcoin and receive your Dogecoins. The transaction is done.

The above is one of the main advantages of decentralized exchanges; you can quickly start making transactions on the platform because there is less regulation, so you don’t need to pass through a whole series of verifications.

However, this can also be problematic. If any problem occurs – like someone trying to scam you – the exchange won’t be able to help you because transactions are carried out person-to-person.

Advantages of centralized exchanges

Ease of use
These platforms usually have user-friendly interfaces. This is an advantage when you’re a beginner in crypto trading.

Many additional tools
These platforms usually offer a wide variety of security and analysis tools to apply to your trading transactions.

High liquidity
CEX platforms have a higher volume of transactions usually because they may offer lower fees for transactions, custodial options, a large variety of crypto assets to trade, ease of use on their platform, and higher and security measures they must follow due to government regulation.

High speed for transactions
The algorithms CEX platforms use can process a high volume of orders per second in real-time. This can help traders react faster to unexpected market changes.

Greater variety
Due to the larger number of registered users, big exchanges can offer a greater variety of digital assets you can operate with. They also support transactions in fiat currency.

Disadvantages of centralized exchanges

Less control of your money
Crypto assets are stored on the exchange since the wallets are part of the platform. This can be pretty bad for you if a platform decides to block your funds.

You do not hold your private keys
Your private keys will remain within the exchange, so there is a risk that you could lose all your money if an attack on the exchange occurs.

Less privacy
These exchanges are regulated by the laws of the country where their companies are located. This may be useful to prevent money laundering, but on the other hand, operators might collect a large amount of personal data from you.

Benefits of decentralized exchanges

Less regulation
Decentralized exchanges are free from any type of limitation or regulation by any public or private entity. Trade between users is direct and, for the most part, you won’t see any KYC or AML procedures needed to access the platform.

More control
As a user, you’ll have full access, control, and responsibility over your private keys and your crypto assets. This means no one can steal them directly from the platform.

Also, the risk for external security threads is minimal because there is no central point to direct an attack. This also decreases the possibility of server failures.

More privacy
Since there isn’t any type of authentication procedure or loading of ID documents, your identity will remain anonymous.

Disadvantages of decentralized exchanges

Greater complexity
DEX platforms are still limited regarding a variety of functions. In addition to that, user interfaces are still pretty complex for the beginner and sometimes even the intermediate user.

Lower transaction speed
Trading on a DEX is usually slower as each transaction must be validated by other nodes (other computers). This can be a problem if you need to react quickly to changing market situations.

Lower liquidity
At present date, you’ll find most traders on centralized exchanges, as the concept of decentralization is relatively new. This means that liquidity is also lower as well as the volume of transactions.

No fiat currency transactions
Even though this is changing, the majority of DEX platforms won’t allow you to perform transactions in fiat currency because it is not part of their decentralized philosophy nor do they want to have to follow KYC and AML regulation.

Top centralized exchanges

Coinbase (This is an affiliate link)
One of the largest and most reputable CEX platforms, Coinbase offers many options for a wide variety of users. You can connect directly with your bank account, but it also supports other payment methods.

Binance
This popular platform operates with all kinds of cryptocurrencies. It’s the largest trade volume in the world and you can do everything, from trading to staking and peer-to-peer (P2P) trading.

Kraken
Kraken is with no doubt one of the most complete exchanges today. Although it’s not the best option for beginner traders, it has an impressive number of options for the expert-level trader.

Gemini
Gemini is a platform that offers a wide variety of cryptocurrencies for all types of users, whether they’re beginners or professional investors. Also, you can use it from any device and its interface is really easy to use.

KuCoin
KuCoin is a very easy to use platform, especially if you’d like to use it from your Android device. Although it doesn’t have a high volume of transactions, here you can find assets that are hard to find in other exchanges.

Bitfinex
If you’re a novice user, Bitfinex is not for you. This platform is designed for expert users, and you can see that in the wide variety of options its user interface has. On the other hand, it has high liquidity and is a platform that cares about responding to its users in case of problems.

Top decentralized exchanges

Uniswap
Uniswap is the best exchange platform in DeFi. It’s easy to use and has a large volume of transactions and liquidity. Being a DEX platform, users can vote for changes to the platform democratically. Their fees are only about 0.3% per transaction.

SushiSwap
SushiSwap is the result of fork (separation) on the UniSwap blockchain and is currently its main competitor. Today, it has $3.06 billion in guaranteed assets and also offers unique features in the DEX environment that go beyond the exchange of crypto assets.

Bancor
Bancor is a pioneering liquidity protocol in the DeFi ecosystem. It’s operated by the Swiss Bancor Foundation, has its own native token (BNT), and offers unique asset protection features for its users. It has a high credibility level.

BurgerSwap
BurgerSwap is a platform founded in 2020 and is very similar to Uniswap. It’s quite easy to use and has managed to position itself very well in the market. It currently has a liquidity volume of around $300 million. Not bad for a starting platform.

Binance DEX
This is the decentralized version of Binance. It’s powered by the Binance Coin (BNB) cryptocurrency and offers quite low fees compared to other similar exchanges. Currently, it’s a fairly solid platform that offers all the advantages of a DEX but requires overcoming a certain learning curve to get the most out of it.

Islamic perspective of CEX and DEX

Scholars in Muslim countries where cryptocurrencies are halal, such as Malaysia, recommend that crypto users buy their cryptocurrency at centralized exchanges (CEX) that are government-regulated as a means to be protected from scammers.

Muslims should also be mindful that some decentralized exchanges (DEX), as well as centralized exchanges (CEX), specialize in lending out your cryptocurrency as loans where you will earn interest off of the loan.

Since some scholars classify Bitcoin, or cryptocurrency as a whole, as currency, then those scholars say that the rules of riba al buyu apply and that it is haram to earn interest from lending out your bitcoin or cryptocurrency. And in the end, Allah knows best.

PLEASE KINDLY SHARE THIS ARTICLE IF YOU’VE FOUND BENEFIT IN IT