Yield farming is a way of earning rewards by providing liquidity to decentralized finance (DeFi) platforms. In yield farming, users lock up their cryptocurrency assets in a smart contract, which is a self-executing program that automatically manages the transactions between users. These assets are then used by the platform to facilitate trades and generate returns.
A yield farming smart contract is a self-executing computer program that is used by yield farming platforms to manage the process of providing liquidity to decentralized finance (DeFi) liquidity pools and distributing rewards to users who contribute to these pools.
Yield farming smart contracts typically operate on blockchain networks, such as Ethereum, and are designed to automate the process of providing liquidity to liquidity pools and distributing rewards to users. These contracts can be programmed with a range of features, such as staking or locking up tokens for a period of time, which can help to incentivize users to provide liquidity and earn rewards.
Yield farming smart contracts typically use a range of algorithms and mathematical models to determine how rewards are distributed among users. These models can be complex, and may take into account factors such as the amount of liquidity provided, the length of time tokens are locked up, and the overall demand for the platform’s native token.
Yield farming platforms offer incentives to users who provide liquidity by rewarding them with their native tokens or other cryptocurrency tokens. These rewards are distributed based on the user’s share of the liquidity pool, which is determined by the amount of assets they contribute.
Yield farming and liquidity pools are related concepts in the world of decentralized finance (DeFi), but they are not exactly the same thing.
A liquidity pool is a smart contract-based pool of funds that is used to facilitate decentralized trading of cryptocurrency assets. Users can contribute their assets to the pool, and in return, they receive liquidity pool tokens that represent their share of the pool. When other users trade on the platform, they pay a fee, which is added to the liquidity pool. This fee is then distributed to the liquidity providers based on their share of the pool.
Yield farming, on the other hand, is a way for users to earn rewards for providing liquidity to these pools. Yield farming platforms incentivize users to provide liquidity by offering rewards in the form of their native tokens or other cryptocurrency tokens. These rewards are distributed based on the user’s share of the liquidity pool, which is determined by the amount of assets they contribute.
In essence, yield farming is a way to earn additional rewards on top of the fees earned from providing liquidity to a liquidity pool. Yield farming often involves strategies such as staking or locking up tokens for a period of time to maximize the rewards earned.
The legal status of yield farming and whether it is subject to securities laws can depend on the specific platform and the jurisdiction in which it operates.
In some cases, yield farming platforms may be considered securities and therefore subject to securities laws, such as registration requirements and investor protection regulations. This can depend on various factors, such as the nature of the platform’s token, how the rewards are distributed, and the involvement of intermediaries.
In the United States, the Securities and Exchange Commission (SEC) has provided guidance indicating that certain tokens and activities related to DeFi may be subject to securities laws, including yield farming. The SEC has stated that whether a particular token or transaction is a security will depend on the specific facts and circumstances of each case. Examples of yield farming platforms which have come under SEC scrutiny include:
- SALT: In 2018, the Securities and Exchange Commission (SEC) charged SALT Lending Holdings, Inc. with conducting an unregistered securities offering through its SALT tokens. The SEC determined that the SALT tokens were securities because they met the criteria of an investment contract under the Howey Test, and were therefore subject to registration requirements under federal securities laws.
- Celsius: In June 2021, the Texas State Securities Board issued a cease and desist order against Celsius Network, a cryptocurrency lending and borrowing platform, for offering unregistered securities through its CEL token. The board determined that the CEL token was a security because it met the criteria of an investment contract under the Howey Test.
- Kik: In 2019, the SEC filed a lawsuit against Kik Interactive, Inc. for conducting an unregistered securities offering through its Kin tokens. The SEC determined that the Kin tokens were securities because they met the criteria of an investment contract under the Howey Test, and were therefore subject to registration requirements under federal securities laws.
Yield farming is also subject to anti-money laundering (AML) laws and regulations in many jurisdictions around the world.
Anti-money laundering laws are designed to prevent the use of financial systems for illegal activities such as money laundering, terrorist financing, and other financial crimes. These laws require financial institutions and other covered entities to implement robust AML compliance programs, including know-your-customer (KYC) procedures, transaction monitoring, and reporting of suspicious activity.
Yield farming platforms that operate in jurisdictions with AML regulations are typically required to comply with these laws and regulations. This may include implementing AML compliance programs, conducting KYC checks on users, and monitoring transactions for suspicious activity.
In addition, users of yield farming platforms may also be subject to AML regulations, depending on their location and the nature of their activities. For example, users who are deemed to be operating as money transmitters or engaging in high-risk transactions may be subject to additional AML requirements.
A yield farming platform may also have to register as a money services business (MSB) in the United States depending on the specific facts and circumstances of the platform’s operations.
The Financial Crimes Enforcement Network (FinCEN), a bureau of the U.S. Department of Treasury, regulates MSBs and has provided guidance on the application of the Bank Secrecy Act (BSA) to virtual currency businesses. According to FinCEN guidance, a person or entity that exchanges virtual currency for fiat currency or other value, or that provides virtual currency transmission services, may be considered an MSB and subject to the BSA’s requirements.
If a yield farming platform provides virtual currency transmission services or exchanges virtual currency for fiat currency or other value, it may be required to register as an MSB with FinCEN. This would require the platform to comply with various AML and reporting requirements, including implementing a written AML program, conducting customer due diligence, and filing Suspicious Activity Reports (SARs) when appropriate.
However, the determination of whether a yield farming platform is considered an MSB is highly fact-specific, and depends on the specific nature of the platform’s activities. Yield farming platforms that only facilitate the trading of cryptocurrency assets and do not engage in virtual currency transmission or exchange for fiat currency may not be considered MSBs.
Several yield farming platforms have faced scrutiny for alleged lapses in AML and KYC procedures. They include:
- Uniswap: In July 2021, Uniswap Labs, the company behind the popular Uniswap decentralized exchange, announced that it was restricting access to some tokens on the platform in response to “evolving regulatory landscape”. The move was widely interpreted as a response to concerns about potential AML violations associated with certain tokens traded on the platform.
- BitMEX: In October 2020, the Commodity Futures Trading Commission (CFTC) charged BitMEX, a cryptocurrency derivatives exchange, with violating AML and know-your-customer (KYC) regulations. The CFTC alleged that BitMEX had failed to implement adequate AML and KYC procedures and had allowed users to trade on the platform without proper verification.
- Binance: In June 2021, the Financial Conduct Authority (FCA) in the UK issued a notice stating that Binance, one of the world’s largest cryptocurrency exchanges, was not permitted to operate in the UK. The FCA cited concerns about potential AML and terrorism financing risks associated with the platform.
About Adam Tracy
Adam Tracy is a payments expert and entrepreneur who specializes in payment systems, blockchain technology, digital currencies, and other emerging technologies. He is the founder of Blockrunner, LLC that provides consulting services to clients in the blockchain, payments and cryptocurrency arenas.
Tracy has been involved in the blockchain, payments and cryptocurrency space since 2013, and he has worked with a wide range of clients, including startups, established businesses, and investors. He has advised clients on legal and regulatory issues related to initial coin offerings (ICOs), cryptocurrency exchanges, regulatory licensing, smart contracts, and other blockchain applications.
In addition to his consulting work, Tracy has founded several companies in the blockchain and cryptocurrency space, including a digital asset hedge fund and a blockchain-based tokenization platform. He is also a proponent of decentralized finance (DeFi) and has been involved in various DeFi projects.
Tracy is also a frequent speaker and writer on blockchain and cryptocurrency topics. He has been featured in a wide range of publications, including Forbes, CoinDesk, and Bitcoin Magazine.
Find Adam: https://linktr.ee/adamtracy