The Decentralized Finance (DeFi) ecosystem has opened the doors to investment opportunities that far exceed traditional interest rates. However, in a world of promises of sky-high returns, most investors fail to replicate successful strategies.

This post breaks down the mechanics behind Yield Farming using Liquidity Pools and the advanced technique of Concentrated Liquidity. Forget fleeting returns and learn the professional process for generating a steady monthly return. If you are ready to stop being a mere holder and become a strategic liquidity provider, this is your ultimate guide.

The main objective of this strategy is to use a portion of the portfolio to generate a monthly return that can be withdrawn and used on a day-to-day basis.

The Liquidity Pool concept was born as a decentralized solution to traditional markets (such as Binance or Nasdaq).

• Centralized Exchanges (CEX): They use software that links buyers and sellers. The exchange requires that there is always a counterparty, and the commissions generated are captured by the exchange.

• Decentralized Exchange (DEX): Protocols such as Uniswap or PancakeSwap use Smart Contracts (Liquidity Pools) containing two currencies (e.g. Ethereum and USDC). This allows the exchange (swap) of one asset for another without the need for an on-the-spot counterparty.

The Role of the Liquidity Provider (LP): LPs contribute their cryptoassets to these Pools. In return, they receive the commissions generated by each swap that takes place in the pool. This is the key difference: the profit from trading, which used to go to the exchange, is now shared among the users providing the liquidity.

To apply Yield Farming profitably, it is crucial to choose the right Pool, which requires applying several filters:

1. Choose the Network (Blockchain): Decide which network to work on (e.g. Base, Ethereum, Solana).

2. Choose the DEX (Protocol): Select the decentralized exchange within that network (e.g. PancakeSwap).

3. Choose the Assets: Select the currency pairs. The priority is not to look for the highest yield, but to choose the currencies you want to have in your portfolio (e.g. Bitcoin and Dollar).

4. Choose the Specific Pool: Within the pair (e.g. CBTC/USDC), there are pools with different commission levels (e.g. 0.05% or 0.01%).

   • Profitability criterion: The most profitable pool is the one with a high volume of swaps and low TBL (Total Blocked Liquidity), since the commissions generated are distributed among fewer people.

Concentrated Liquidity pools (as in Uniswap v3 and its derivatives) require the LP to define a price range in which its capital will be active.

• Impact of Ranks:

  • Wide range: Generates less commissions, but keeps the capital active for a longer period of time.

  • Narrow range: Generates a higher amount of commissions (higher APR), but has a higher risk of going out of range.

• Strategic Approach: The goal is to find the "smallest possible range, but wide enough to stay in range". Technical analysis is fundamental to determine these limits. It is recommended to use one-day candlesticks at the beginning.

The inherent risk of the Pools is the Impermanent Loss (IL), which occurs when the price of the asset moves:

• Rebalancing Mechanism: The pool always rebalances the percentages of the assets. If an asset falls (e.g. Bitcoin), the pool sells the stronger asset (dollar) to buy the weaker one (Bitcoin), accumulating the falling currency. If the asset rises, the pool sells the rising one (Bitcoin) to accumulate the stable one (dollar).

• Extreme Consequence: If the price exits the lower range, the LP stays 100% in the volatile currency (Bitcoin). If it exits the upper range, it stays 100% in the stable currency (dollar).

• IL Mitigation Strategy: Asymmetric ranges are advised. By opening a wider range down (e.g. with more dollars than Bitcoin), the LP hedges under a drop, slowly buying the cryptocurrency as it falls. This helps to be more conservative and mitigate IL.

The practical process of opening a pool is as follows:

1. Connection and Filter: Connect the decentralized wallet to the DEX (e.g. PancakeSwap) on the chosen network (Base) and select the pool with the best performance (high volume, low TBL).

2. Range Definition: Enter the minimum and maximum price (e.g. from 100,000 to 118,000 for CBTC/USDC).

3. Asymmetric Calculation: The platform will indicate the exact amount of both assets (e.g. 320 USDC and the amount of CBTC needed) according to the price position in the range.

4. Swap execution: It is necessary to perform a swap from the currency held (e.g. USDC) to the volatile currency (CBTC) in the DEX, to obtain the exact amount required by the pool.

5. Add Liquidity: The transactions are confirmed to approve the assets and the "Add Liquidity" process is completed, activating the position.

6. Position Management: The "My Positions" section allows you to monitor generated commissions (in BTC and USDC) and use the Harvest function to collect them. You can also Stake the position to receive additional incentives from the protocol (e.g. CAKE currency from PancakeSwap).

Yield Farming with concentrated liquidity is a powerful and professional tool. It requires a strategic approach to choosing assets, defining price ranges with precision (based on technical analysis) and managing the risk of Impermanent Loss. With good management, it is possible to achieve the goal of a constant monthly passive income, exceeding 5% return.