When it comes to earning a passive income, the cryptocurrency industry is delivering. With a multitude of options available in the DEX and DeFi (decentralized finance) space across several blockchain platforms, the real question when it comes to passive income is which one is better: staking vs yield farming.
Understanding Their Key Differences
While the one is known to deliver higher rewards, the risk associated is far greater. In this piece, we’re exploring the pros and cons of each and analyzing the risks and advantages associated with these two investment tools.
Staking and yield farming revolve around the concept of making money from already established crypto portfolios. Similar to earning interest on money already in the bank, these options allow users to leverage their crypto portfolios, earning more crypto in the process.
Prior to the DeFi boom in 2020, previously mining crypto was the only way to earn crypto. After mining came staking, and after staking came yield farming. Let’s explore the new age crypto-generating services and consider their advantages and risks.
What Is Staking?
Originating from the Proof-of-Stake consensus, the energy efficient alternative to Proof-of-Work, staking involves “locking up” your crypto assets in a particular location (generally a smart contract).
In PoS networks, nodes are required to stake a certain amount of cryptocurrency before being able to validate transactions. This is done to ensure that they act in an appropriate manner, as they have a personal stake in the network.
With the rise in decentralized exchanges (DEXs) and DeFi platforms, many projects are now allowing users to stake cryptocurrency in order to earn rewards without having to go through the process of becoming a node. While the goal of the user is to earn rewards, the real driving force behind staking is to secure a network. The more stakers there are on a network, the more secure the blockchain is.
Ethereum 2.0 provides a good example of this. All nodes on the network are required to stake 32 ETH in order to become a validator. Some centralized and decentralized exchanges provide access to users who wish to participate in this staking, allowing them to earn returns based on the portion of their stake, and handle the node set up and operation in-house.
What Is Yield Farming?
Yield farming involves users lending their cryptocurrency to DeFi platforms and earning interest through doing so. Despite some platforms offering a fixed interest rate while others have dynamic models in place, a general rule of thumb is that the more (and the longer) the user lends their crypto the higher the rewards.
Through providing liquidity to DEXs, users in return earn a portion of the platform’s fees, paid by the token swappers accessing the liquidity. The process is facilitated by smart contracts which automatically execute the agreed-upon exchange. On occasion, yield farming can also be referred to as liquidity mining.
Due to the industry being flooded with new DeFi projects, there is a competitive circle of constantly changing APYs (Annual Percentage Yield). This drives users to move their funds around in order to find the highest return, regularly changing where they lend their funds to.
The downside to this is that moving funds to different liquidity pools requires constantly paying gas fees, which (depending on the network at any given time) can be a costly exercise.
Platforms offering yield farming include the likes of Uniswap, Pancake Swap and Aave.
Staking vs Yield Farming
In essence, staking revolves around securing a network while yield farming is centred around providing liquidity. However, both these options provide returns.
Looking at the APY rates, with staking users are looking at returns between 5% and 12%, while yield farming offers between 2.5% and 250%.
Staking is also considered to be a more stable option of the two, with yield farming prone to losses caused by a sudden bearish market, bad actors or high gas fees.
Yield farming allows users to have more control over their funds as these can be moved at any time while staking is locked in for a fixed amount of time.
Risk vs Reward
Both yield farming and staking are common practices in the industry, but as mentioned earlier yield farming revolves around liquidity while staking around network security. Yield farming also notoriously comes with higher APYs but carries greater risk. When it comes to choosing an investment option, it’s best to weigh up the risks and rewards against your personal trading strategies.