Key Takeaways
- Yield farming involves lending cryptocurrencies to DeFi protocols to generate rewards through additional crypto assets. Staking, on the other hand, involves locking your crypto tokens into a network to help verify and secure transactions.
- In terms of operations, yield farming is more complicated than staking. Yield farmers have to choose platforms and switch as the need arises, while stakes only choose a platform and receive yields immediately.
- Yield farming offers much greater potential but is riskier than staking. Staking offers smaller yields but comes with fewer risks.
Yield Farming vs. Staking: Which Is Better?
Staking and yield farming are additional ways Decentralized Finance (DeFi) offers crypto investors keen on making passive income to earn interest from their idle cryptocurrencies. Our yield farming vs. staking guide interrogates the two most popular DeFi products to help you decide.
Staking and yield farming are currently the most popular methods of earning passive income in decentralized finance. DeFi enables people holding idle cryptocurrencies to leverage them by locking them up to support blockchain protocols and earn rewards in return. While they may look alike, yield, staking, and yield farming have unique characteristics, differences, and benefits that you need to consider if you want to generate passive income within the DeFi ecosystem.
As crypto investments continue to gain popularity and beginners explore investment practices that are less risky than active trading, DeFi comes into mind. Since there’s a significant debate among investors on what gives better profits, we dissect these passive income strategies to show you how they differ and how they suit different investor groups.
What is Yield Farming?
Yield farming is a practice that allows cryptocurrency holders to use their otherwise idle tokens to provide liquidity to decentralized exchanges. Users — yield farmers — lend and borrow their otherwise idle crypto assets on decentralized exchanges (DEXs) and earn crypto rewards in return. The expected returns on investment (ROI) are annualized — calculated over a year — and measured in annual percentage yield (APY).
How Does Yield Farming Work?
Investing starts by depositing and locking coins to a liquidity pool through smart contracts — codes that automate financial agreements between two parties. The pools power a token farm where other users can borrow or exchange the tokens to use for speculation. You become a liquidity provider or a yield farmer when you add funds to a pool on platforms like Aave or Compound.
Fees from the DeFi platform generate the return on investment (ROI) for locking up crypto in a liquidity pool. Note that it’s not investing in tokens like Ethereum (ETH) but lending ETH through DEXs, which counts as yield farming. It’s common practice for yield farmers to reinvest their token rewards or shift funds between platforms to maximize returns.
What is Staking?
Staking comprises locking up an amount of crypto to support a blockchain ecosystem and earning interest. Like placing a “fixed deposit” in a bank, staking is an impressive way to generate passive income using cryptocurrencies. The practice also limits the amount of the crypto asset in circulation and increases its value. Staking uses the energy-efficient proof-of-stake (PoS) consensus mechanism instead of the energy-intensive proof-of-work (PoW) to validate transactions on blockchain platforms.
How Does Staking Work?
To start staking, you must pledge your tokens to a DeFi platform and become a validator. The platform then randomly chooses validators to authenticate transaction blocks. Stakers with more tokens locked stand a higher chance of being selected as validators.
Staking only works with cryptocurrencies that use proof-of-stake; examples include Cardano, Polygon, and Ethereum. Staking also helps secure a blockchain network, meaning higher stakes lead to a more secure and decentralized ecosystem.
Yield Farming vs. Staking: Which One is Better?
Choosing between yield farming and staking to earn passive income depends on your take on risks, goals, and crypto knowledge.
1. Risk and Rewards
Yield Farming: Yield farming has a higher potential for earning because users are exposed to platform-specific rewards and liquidity provider fees. Nonetheless, yield farming has greater risks, such as smart contract vulnerabilities and impermanent loss.
Staking: Staking is more stable and predictable but has lower yield potential. Moreover, it is less risky as it involves supporting the operations of a single network.
2. Liquidity Requirements
Yield Farming: Users must provide liquidity by depositing their crypto assets into a liquidity pool. The amount of liquidity you provide determines how much potential reward you receive.
Staking: To participate in staking, you need to hold a certain amount of tokens in a smart contract or designated wallet to earn rewards.
3. Flexibility and Lock-Up Period
Yield Farming: You can withdraw your liquidity at any time you choose. However, should the value of your asset change significantly, you may experience impermanent loss.
Staking: You cannot access the crypto assets you lock up during the chosen period. The lock-up period can vary based on the platform you choose.
Yield Farming vs. Staking: What Investors Need to Consider?
Risk Tolerance: When choosing yield farming vs. staking, you must carefully evaluate your risk tolerance. Take the time to understand all the risks associated with your strategy of choice, including market volatility, smart contract vulnerabilities, and impermanent loss.
Return on Investment: Calculate and weigh the potential return on investment, as well as carefully consider factors like the Annual Percentage Yield (APY), platform-based incentives, and tokenomics when choosing between staking and yield farming.
Diversification: You may want to consider diversifying your strategies by combining staking and yield farming to optimize risk-adjusted returns.
Conclusion
Staking and yield farming are income strategies within the DeFi space that enable investors to earn passive income by offering liquidity to blockchain networks and DeFi platforms. Staking is less risky but promises lower, predictable, and stable rewards. On the other hand, yield farming promises greater rewards but comes with substantial risk exposure.
As with all other investment strategies, choosing between yield farming and staking requires thorough research, assessment of risk factors, and alignment of the strategy with your risk tolerance and financial goals. Take the time to understand the subtle differences between staking and yield farming to make an educated decision so you can optimize your DeFi investment strategies and become a part of the emerging decentralized finance ecosystem.
