The emergence of decentralized finance (DeFi) has opened doors for individuals to broaden their investment portfolios and seek passive income through techniques called staking and yield farming.
Both staking and yield farming operate autonomously and cater to distinct investor preferences. Yet, each carries its own set of risks, demanding thorough consideration before adoption.
Despite the appeal of passive income, newcomers must grasp the disparities between these methods and acknowledge the associated risks.
This piece delves into yield farming and staking, elucidating their shared traits and disparities.
Yield Farming Mechanism
Source: Freepik
A DeFi protocol functions akin to a digital framework or set of regulations permitting individuals to conduct financial transactions like borrowing, lending, or trading using cryptocurrencies rather than traditional currencies. Essentially, it operates akin to a digital bank or stock exchange, functioning online without reliance on physical premises or conventional financial institutions.
Yield farming in the realm of cryptocurrency involves leveraging your digital assets to provide liquidity to DeFi protocols.
Liquidity, in this context, entails making your cryptocurrency accessible for others to utilize within DeFi protocols, akin to contributing to a pool from which others can easily borrow or trade. By doing so, participants earn rewards in the form of additional tokens or interest, effectively mirroring the concept of lending out your cryptocurrency or engaging in diverse DeFi activities to optimize returns.
To illustrate further, envision yield farming in cryptocurrency as analogous to sowing seeds in a garden to cultivate more produce. Instead of seeds, you allocate your cryptocurrency into specialized digital gardens known as DeFi platforms.
These platforms utilize your cryptocurrency for various purposes such as lending or trading, and in return for entrusting them with your crypto, you receive rewards in the form of additional cryptocurrency. Much like the process of farming yielding more crops, yield farming generates additional cryptocurrency.
Yield farming entails inherent risks for several reasons.
Firstly, it frequently involves engagement with novel or less-established DeFi projects, potentially lacking comprehensive testing for security or reliability.
Additionally, the rewards offered in yield farming are subject to fluctuations, meaning anticipated earnings may not always materialize.
Furthermore, there exist risks associated with smart contract bugs or vulnerabilities, which could result in financial losses.
Lastly, the cryptocurrency market itself exhibits volatility, leading to unexpected fluctuations in the value of investments. Thorough research and comprehension of risks are imperative before engaging in yield farming.
How Much Can Yield Farmers Make, or What You Shall Know about Annual Percentage Yield?
Source: Freepik
A rough estimate of profitability in yield farming can be outlined as follows:
- Moderate APYs (5–15%): Representing a sustainable range for long-term yield farming, this category includes several established platforms offering this rate for well-established crypto assets.
- High APYs (15–50%): These farms often involve riskier assets or more intricate strategies. While potential rewards are elevated, so are the associated risks.
- Extremely high APYs (50%+): While these may seem enticing, exercise extreme caution. They typically involve experimental platforms or less-liquid assets, significantly heightening the risk of losing your initial investment.
However, the profitability of yield farming hinges on various factors, including interest rates in lending protocols, trading fees, and token performance. While potentially lucrative, returns are susceptible to market volatility and platform-specific dynamics.
Delving deeper, profitability depends on:
- The specific platform: Different platforms offer various farm and pool options, each with its potential APY. Higher APYs may signal higher risks.
- The chosen crypto assets: APY can fluctuate based on the cryptocurrencies invested in. Some offer steady, low APYs, while others boast high but volatile rates.
- Market conditions: Overall market trends profoundly impact earnings. Bullish markets typically yield higher returns, whereas bearish markets can erode profits or result in losses.
- Personal farming strategy: How one combines platforms, pools, and assets influences overall yield.
While some farmers have reported substantial gains, such as triple-digit APYs, it's essential to recognize these aren't guaranteed and may be short-lived. Platforms often adjust reward rates, and losses remain a possibility.
Crypto Staking Mechanism
Source: Freepik
Another popular way to earn passive income from crypto assets is through staking. With staking, you essentially "lock up" your tokens in a staking pool or masternode in exchange for staking rewards.
This requires some initial investment and technical knowledge, but it can also offer fairly steady returns in the future.
Unlike yield farming, staking is a much more conventional approach to generating passive income from crypto assets. It has been around since the early days of blockchain and remains a popular option for many investors today.
How Much Can You Make on Staking?
The rewards obtained through staking are influenced by various factors, including the following ones.
Staking platform
Different platforms employ staking as a means of generating passive income. Some platforms utilize indirect staking, where users surrender their tokens in exchange for a fixed reward. Conversely, less centralized platforms allow users to directly contribute their tokens to staking pools for liquidity.
Decentralized staking pools often offer superior rewards compared to centralized platforms since they receive funds directly from the source and involve fewer intermediaries. However, as discussed later in this article, a high reward rate doesn't always indicate optimal outcomes.
Number of staking participants
The rewards distributed decrease as the number of stakeholders participating increases. This is particularly evident among those who delegate their coins to a blockchain validator. Consider this: Validators receive rewards directly from the blockchain and must share them among all delegators. Consequently, fewer delegators result in higher rewards per participant.
Staking weight
Staking rewards are typically distributed in percentages rather than fixed amounts. Thus, the greater the amount staked, the higher the rewards earned. For instance, an 8% Annual Percentage Yield (APY) for 50,000 staked SOL yields 4,000 SOL, whereas the same 8% rate equates to 4 SOL when staking only 50 tokens.
Staked cryptocurrency
Different cryptocurrencies offer varying rewards. Some provide higher rewards but are less valuable, while others offer fewer rewards but possess greater value.
Additionally, staking on a crypto exchange with a native token may yield higher rewards when staking the exchange's platform token. Profitable coins suitable for staking will be suggested later in this article.
The returns you can earn through staking will depend on several factors, including the staking pool or masternode you choose, as well as market conditions.
Yield Farming vs Staking: Differences and Similarities
Source: Freepik
Yield farming and staking serve as avenues for earning additional cryptocurrency, yet they differ significantly. Here's a detailed comparison.
Mechanism
Yield farming
Resembles an intricate, multi-layered garden where you deposit your crypto into various "fields" like liquidity pools, lending protocols, and margin trading platforms. Each field carries its own rules and risks, often involving actively managing your crypto to maximize rewards.
It's akin to tending to your crops diligently and adjusting strategies based on changing conditions.
Staking
Functions more like a low-maintenance orchard where you lock your crypto in a designated "stake" on a specific platform, typically supporting blockchains that utilize the Proof-of-Stake (PoS) consensus mechanism. By staking, you contribute to the network's security and validation and earn regular rewards in return. It's akin to planting a fruit tree, occasionally watering it, and observing steady growth over time.
Complexity
Yield farming
Demands extensive research and technical expertise. Understanding different platforms, pool mechanics, and tokenomics is crucial for making informed decisions in the dynamic landscape. It's comparable to being an experienced gardener with deep knowledge of soil science and pest management.
Staking
Generally simpler to initiate. You select a platform and a staking pool for your preferred PoS cryptocurrency, and rewards begin accumulating automatically. It's like planting a familiar tree and relying on basic gardening principles.
Risks
Yield farming
Involves higher risks due to complexity and potential experimental nature. Risks include impermanent loss (value decrease due to price fluctuations), smart contract vulnerabilities, and rug pulls (scams), among others.
It's akin to exploring uncharted territory with less-established crops.
Staking
Risks primarily revolve around price volatility and potential platform breaches. While typically safer than yield farming, staked crypto can still depreciate, and choosing unreliable platforms can result in losses. It's akin to caring for a fruit tree during a storm, hoping it withstands harsh conditions.
Rewards
Yield farming
Offers potential for significantly higher returns, sometimes reaching triple-digit Annual Percentage Yields (APYs). However, these rewards are often short-lived and come with elevated risks. It's akin to reaping a bountiful harvest overnight, with the risk of spoilage.
Staking
Provides lower but consistent and predictable rewards, typically ranging from 5% to 15% APY. It's akin to regularly harvesting ripe fruit from your orchard, ensuring a steady supply over time. Consider exploring CoinW Earn’s ongoing staking promotions to maximize your crypto assets.
Ultimately, the optimal choice depends on your risk tolerance, knowledge level, and financial objectives. For beginners, staking may offer a safer entry point, while yield farming could potentially yield greater rewards for those comfortable with higher risks and active management of their crypto assets.
Investment Risks: Yield Farming and Staking
When comparing yield farming to staking, users must also consider the security infrastructure and associated risks.
Yield farming protocols are susceptible to various risks that could result in the loss of user funds. Price fluctuations of tokens, including impermanent loss, where the price of one token changes concerning the other while coins are locked in a liquidity pool, are among these risks.
Additionally, bugs or errors in smart contracts can expose protocols to smart contract risks, rendering them vulnerable to hacking. Rug pulls, common in new yield farming projects led by shady, anonymous developers, pose another risk to yield farmers. Research indicates that users lost over $10 billion to rug pulls and DeFi hacks throughout 2021. More recently, estimates attribute $158 million to DeFi hack losses in November 2023, compared to $184 million for CeFi hacks.
In contrast, staking offers comparatively greater security as stakers must adhere to strict guidelines to participate in a blockchain’s consensus mechanism. In Proof of Stake blockchains, malicious users risk losing their staked assets through slashing if they attempt to manipulate the network for increased rewards.
Moreover, unlike yield farming, staking is better shielded from hacks and scams.
Impermanent loss and slashing: yield farming vs staking
Yield farmers providing liquidity to a liquidity pool are susceptible to "impermanent loss" when token prices change from their initial deposit. Liquidity pools adjust for token prices during volatile market conditions, potentially resulting in permanent loss if users withdraw their assets when token prices deviate from their deposit time.
Staking, however, is not vulnerable to impermanent loss. While stakers may incur losses if token prices of their staked assets decline due to a bear market, there's no adjustment of the total value in liquidity pools, mitigating impermanent loss risk.
Nevertheless, there's an additional risk of slashing in staking, where a validator's supply of staked tokens is deducted for engaging in harmful network activity, such as failing to validate legitimate transactions or double-signing transactions.
Learn more about the DYOR process and how to analyze IDO projects with our BullPerks DYOR Guide!
Conclusion. Yield Farming vs. Staking. What Is the Best for Your Crypto Investments?
Thus, liquidity mining is a subset of income farming, which itself is a subset of stakes. All three of these methods are just ways to make unused crypto assets work.
Profit farming aims to generate the highest possible income, while staking aims to help the blockchain network stay secure.
You should always consider a bear market, volatility risk, risks of losing money, interest rates, digital assets, DeFi platforms, how to get involved early, how to validate transactions, and when to pay transaction fees and gas fees.
You should also learn how to facilitate crypto trading, about traditional staking options, how to use lending services and decentralized exchanges, get information about the staking debate, automated trading, associated risks, token rewards, yield farming offers, and many other things.
Whether you're an average investor or a yield farmer, looking for stable returns over time, deposit funds, or simply want to explore the exciting world of DeFi (including DeFi lending protocol), staking and yield farming are all great options to consider.
And don't forget about another option – to trade cryptocurrencies (crypto trading). So why not give it a try today when you've learned a lot about crypto farming vs staking, yield farming, yield farmers, comparing yield farming with liquidity pools, and more?
Furthermore, you will be interested in smart contracts, how to validate transactions, passive income strategies, transaction fees, automated market makers, liquidity providers, yield farming platforms, and more.
