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The rise of decentralized finance (DeFi) has enabled users to diversify their portfolios and pursue passive income through staking and yield farming strategies.
However, these two methods work independently and cater to different types of investors. While earning high-yield passive income is one of DeFi’s most appealing features, newcomers must understand how these two approaches differ.
This article closely examines yield farming and staking, explaining their key similarities and differences.
What is Crypto Farming?
Decentralized exchanges provide DeFi yield farming as a service (DEX). The basic idea is that you will lend your digital tokens to a DEX for it to give buyers and sellers adequate levels of liquidity on a specific trading pair.
- Pair / single token
- For instance, suppose that the DEX offers the trading pair BNB/PXP.
- To swap BNB for PXP or PXP for BNB, there needs to be an adequate amount of liquidity available to cover the exchange.
It is where yield farmers enter the picture. To earn a return on your tokens, you must deposit the same amount in BNB and PXP. For example, at current exchange rates, $1,000 is in BNB and PXP.
You will earn a percentage of trading fees as long as your BNB and PXP tokens contribute to the BNB/PXP liquidity pool on your chosen DEX. These are the fees buyers and sellers must pay to gain access to a trading pair on a DEX.
As a result, yield farming is an excellent way to generate passive income from your idle tokens. However, you must access both passes from a trading pair to provide liquidity.
Advantages of Crypto Farming
As a yield farmer, you could lend digital assets like Dai via a DApp called Compound (COMP), which then lends coins to borrowers. Interest rates fluctuate according to the level of demand. The interest is calculated daily, and you are paid in new COMP coins, which you can appreciate. Some of the most popular DeFi protocols for yield farming are Compound (COMP) and Aave (AAVE), which have helped popularise this segment of the DeFi market.
Rather than simply storing your cryptocurrency in a wallet, you can effectively earn more cryptocurrency through yield farming. Transaction fees, token rewards, interest, and price appreciation are all ways for yield farmers to profit. Yield farming is also a less expensive alternative to mining because no costly mining equipment or electricity is required.
Intelligent contracts or depositing a few different tokens onto a crypto platform can be used to execute more sophisticated yield farming strategies. A yield farming protocol typically maximizes returns while considering liquidity and security.
What is Staking?
Staking is the process by which users pledge to secure a Proof-of-Stake blockchain network by locking their crypto assets. Stakers set up individual nodes to validate transactions and add new blocks to the blockchain network.
The Users who deposit crypto funds into a staking pool receive staking rewards for protecting blockchain networks from malicious actors. The blockchain network chooses a validator node randomly, with high-stake nodes having a better chance of validating transactions. Users earn governance tokens and a percentage of the platform’s fees with the addition of each new block.
How DeFi Impacts Staking
Decentralized finance (DeFi) is an umbrella term for financial applications that use blockchain networks to eliminate the use of intermediaries in transactions.
For example, if you take out a bank loan now, the bank acts as an intermediary by making the loan available. DeFi intends to eliminate the need for such an intermediary by utilizing innovative contracts, which are essentially computer code that executes based on predetermined conditions. The overarching goal is to lower the costs and transaction fees associated with financial products such as lending, borrowing, and saving.
Regarding staking, there are a few extra precautions investors should take when engaging in DeFi. These are some examples:
- Diversifying into other staking projects and platforms
- Evaluating the liquidity of betting tokens
- Looking into whether or not rewards are inflationary
- Considering the security of the DeFi platform
Because DeFi platforms are decentralized — and thus less vulnerable to security breaches — they are frequently more secure than traditional finance applications. Tokens can be staked with various already established projects, including Polkadot and The Graph. Ethereum is also shifting from PoW to PoS validation, which means that network transactions will be entirely confirmed by staking.
Crypto Farming vs. Staking: What’s the Difference?
While yield farming and staking are novel ways to generate passive income, they differ in several ways.
1. Levels of complexity
The ease of access and associated learning curves for yield farming and staking differ. Yield farming is typically more complicated because it necessitates extensive research to make profitable investments.
Liquidity providers must find a liquidity pool that offers competitive interest rates to provide liquidity. They must choose a token pair and a DeFi platform that provides a customizable or equilibrium liquidity pool. Similarly, lenders and borrowers must work together to develop a DeFi protocol that requires little or no collateral for loans.
Staking is much simpler to understand because users only need to choose a staking pool in a Proof-of-Stake network to stake their crypto assets. Because staking typically involves a lock-up period during which stakers cannot withdraw their deposits for a set time, the process is primarily passive once users place their stakes. In contrast, to yield farming, which requires active management to maximize returns, staking requires little effort from users.
2. Deposit times
Flexibility is an essential consideration in the yield farming vs. staking debate.
To earn rewards from yield farming protocols, yield farmers do not need to lock their crypto in a liquidity pool. They can provide liquidity to any liquidity pool or withdraw their tokens if the returns aren’t high enough. In the absence of a minimum lock-up collection, yield farmers can even transfer funds from one pool to another to maximize their profit.
Staking, on the other hand, entails fixed lock-up periods during which users are not permitted to withdraw their stake. Smart contracts in staking protocols ensure that users cannot withdraw funds before the term expires. Regardless of market conditions, you cannot withdraw funds or switch from one pool to another.
3. Transaction fees
When deciding between yield farming and staking, gas fees can be a deciding factor.
To execute fund transfers, yield farmers must pay transaction fees when switching between liquidity pools to maximize profits. Ethereum users may have to pay exorbitant gas fees for a simple on-chain transaction. Farmers must ensure that high gas fees do not reduce their returns when switching liquidity pools.
Stakers do not have to pay transaction costs because staking requires locking up user funds with no opportunity to switch pools. Instead, when they validate transactions, they earn a percentage of network fees. Staking has much lower maintenance costs for generating returns when compared to liquidity pools.
4. Token requirements
The number of tokens required for yield farming and staking investments differs.
Yield farming necessitates using a pair of tokens, such as USDT-USDC or BTC-ETH, to provide liquidity to liquidity pools. For customizable collections, users can offer a flexible ratio of these tokens to the trading pair. They must, however, supply tokens in a 50-50 split to equilibrium pools with trading pairs of equal value.
Staking only requires users to lock up one token in the staking pool, so stakers do not need to purchase two tickets of equal or variable value to provide liquidity. It lowers the overall cost of staking participation.
5. Profit margins
Profitability is yet another distinguishing feature.
Yield farming provides a dynamic and profitable Annual Percentage Yield (APY) that varies depending on the liquidity pool. The APY varies according to market metrics, including available liquidity, arbitrage opportunities, and overall volatility. Farming interest rates are typically higher than staking rates, with new coins providing higher returns than high-capital tokens such as ETH.
Staking, on the other hand, provides a fixed APY, allowing users to forecast future returns and plan accordingly. Although the interest rate is lower than in yield farming, a consistent percentage is often preferable for low-risk investors. Furthermore, those who lock up their tokens for more extended periods earn higher APYs than those who lock up for shorter periods.
6. Investment risks
When comparing yield farming vs staking, users must be aware of the security infrastructure and associated risks.
Yield farming protocols are vulnerable to several risks that can result in the loss of user funds. Smart contract bugs or errors can create an intelligent contract risk, making the protocol vulnerable to hacking. Rug pulls are standard in new yield farming projects led by shady, anonymous developers. According to research, DeFi hacks will cost users more than $10 billion in 2021.
Staking is more secure than mining because stakers must adhere to strict guidelines to participate in a blockchain’s consensus mechanism. Malicious users on a Proof-of-Stake blockchain may lose their staked assets if they attempt to manipulate the network for greater rewards. Staking, as opposed to yield farming, is more secure against hacks and scams.
7. Impermanent loss
When yield farmers provide liquidity to liquidity pools, they are vulnerable to “impermanent loss.” It is the point at which the value of the tokens changes from when they were first deposited.
During volatile market conditions, liquidity pools maintain equilibrium and adjust for token prices. If users withdraw their assets after token prices have deviated from the time of deposit, the temporary loss becomes permanent.
Staking, however, is not subject to any temporary loss. Users may lose money if the token prices of their staked assets fall due to a bear market, but because liquidity pools do not adjust the total value, stakers will not lose money due to impermanent loss.
Crypto Farming vs. Staking: Similarities
Despite their differences, yield farming and staking share a few things.
1. Passive income
Yield farming and staking are both methods of generating passive income. Users who do not want to trade a cryptocurrency can earn interest on their investments by yield farming and staking. Although each strategy has a different APY, both can be profitable and provide high returns.
Yield farming and staking provide investors with novel ways to beat high inflation rates in legacy markets. Users will not earn anything if they keep their assets in a crypto wallet. Rather than sitting on cryptocurrency, investing it through yield farming or staking protocols may be more prudent. Users can earn interest on their cryptocurrency holdings to offset the value depreciation caused by inflation.
3. Volatility risk
Users who invest in yield farming and staking platforms face the usual volatility in cryptocurrency markets. Tokens in staking and liquidity pools may fall in value during bear markets. When prices fall overall, both yield farmers and stakers may lose money. Farmers may face an additional liquidation risk if the value of their collateral depreciates and the protocol liquidates assets to recover costs.
Who is Crypto Farming suitable for?
Not all investors are suitable for yield farming protocols. Yield farming is only feasible for those with a highly high-risk tolerance. Users are more likely to lose money if they do not follow proper investment advice.
Yield farming platforms have a higher APY than staking platforms, but the initial investment is also increased. Yield farming is ideal for investors with the capital to invest in these protocols.
Investors involved early in liquidity mining for an upcoming project can earn a lot of money. Higher APYs are frequently used to incentivize liquidity pool funding in new protocols. However, investors must be cautious of smart contract vulnerabilities and prefer audited companies with doxxed and active developer teams.
Yield farming is also suitable for generating passive income for traders who hold low trading volume tokens, as it allows them to earn interest on otherwise idle assets. Finally, yield farming is ideal for investors who want to keep their investments flexible and do not want long lock-up periods.
Who is Staking suitable for?
Investors with a low-risk tolerance would benefit more from staking their assets. Furthermore, because of the low-risk exposure, staking is easier for new crypto users who are still learning the intricacies of the market.
Staking is one of the most secure ways to generate passive income by validating crypto transactions and increasing transaction throughput. Furthermore, the initial investment in staking is much lower than the initial investment in yield farming, making it accessible to many investors.
Staking also provides fixed interest rates, allowing helpful comparisons Comparedle depositing funds. Users may prefer a consistent investment APY to predict their financial outcomes better.
However, it is essential to note that staking is not a flexible strategy because the protocols lock up user funds for a set period. Staking may not be suitable toho require constant access to their funds. Short-term staking options are available, decentralizedcally offer lower APYs than yield farming.
Overall you found this yield farming vs. staking comparison maneuvering compared to other financial markets; staking and yield farming are still relatively new passive income strategies. Staking and yield farming are sometimes interchangeable, and staking may even be considered a subset of yield farming. Both methods of earning passive income rely on holding crypto assets in order to earn rewards, and each strategy allows investors to participate in the value of the decentralized financial ecosystem.
Staking may be a more intuitive concept to grasp, whereas yield farming may necessitate some strategic manoeuvring to reap higher profits. Both products have potentially attractive rates of return. Choosing between yield farming and staking is a matter of investor sophistication and what is best for your portfolio.