Yield Farming vs. Staking

Learn how these concepts work and how you can include them in your passive income strategies.

Hodling crypto assets is not the only way to make money in the crypto world. There are many other ways to earn crypto passive income, but yield farming and staking top the list. These two methods have proven effective in providing a consistent income without the extreme risks associated with crypto trading. This article will answer all your yield farming and staking questions. Stick around to learn how these concepts work and how you can include them in your passive income strategies.

Is Yield Farming the Same as Staking?

The terms "yield farming" and "staking" are often thrown around in crypto forums, which might confuse you about whether they’re the same thing. Although some people use these terms interchangeably, they are different things. Understanding the difference will save you from investing blindly. To help you do so, we will discuss what both yield farming and staking entail and then highlight their major differences.

So, What Is Yield Farming?

Yield farming, or liquidity farming, is among the latest crypto passive income opportunities. It allows you to invest in crypto assets in a liquidity pool to earn rewards. It’s similar to earning interest from saving in a bank account. When you invest in yield farming, you become a yield farmer or liquidity provider.

How Does Yield Farming Work?

To invest in yield farming, you must deposit crypto assets in a liquidity pool to help them maintain consistent liquidity. The assets are lent out to investors looking for funds for speculation or other purposes. The money made from the loans is distributed among yield farmers according to the invested amount. Most of these processes are performed using smart contracts, which are computer codes used to automate blockchain functions.

Besides paying interest, most lending protocols also reward liquidity providers with native tokens. This increases the chances of making more money since your tokens could also gain value.

Liquidity pools are also crucial for Automated Market Makers (AMMs). Unlike the traditional system that uses buyers and sellers, AMMs use liquidity pools to provide automated and permissionless trading. They issue liquidity providers with special tokens (LP tokens) that make it easier to track their investments in liquidity pools.

Best Yield Farming Protocols

There are many yield farms you can invest in today. They are hosted on different blockchains and offer varying rewards. Below are excellent yield farms to consider:

Curve Finance

Curve Finance has over $9.7 billion in total volume locked (TVL). This platform has a market-making algorithm that enables it to maximize profits from the locked funds. Therefore, you are assured that your crypto assets will earn you handsome profits. Curve Finance offers an APY of around 10%.

Aave

This open-source protocol allows you to invest in digital assets and earn compound interest in AAVE tokens. Aave also has a $21 billion TVL, which is among the highest in the market. Its APY is about 15%.

Uniswap

Uniswap is a popular AMM that requires you to invest on both sides of the liquidity pool to make money. It offers two protocols you can invest in - Uniswap V2 and Uniswap V3. Uniswap V2 has a TVL of $5 billion, while Uniswap V3 has around $2 billion.

Pancake Swap

This one uses an Automated Market Maker system that requires investors to trade against the liquidity pool. It has a TVL of around $4.9 billion, and its APY goes up to 400%.

Those are some of the most popular yield farming protocols in the market. However, there are other great options you can also check out, such as:

  • Compound

  • Instadapp

  • SushiSwap

  • Venus Protocol

  • Balancer

Risks of Yield Farming

Yield farming is a legit investment that can help you earn passive income from idle crypto assets. However, it also involves some risks. Below are some of the associated risks:

Rug Pulls

Rug pulls are among the most common scams in the crypto market. This refers to when a crypto developer takes people’s crypto funds and disappears without refunding them. This scam has been rampant over the last two years.

Volatility

Yield farming involves investing in volatile crypto assets, which can enter a bear market at any time. This can easily cause an impermanent loss, which is when the price of your crypto assets drops dramatically. Therefore, even if you withdraw your assets, they will be worth less than the invested amount.

Smart Contract Risk

Most crypto platforms use smart contracts, which can sometimes be buggy. This can give hackers a chance to invade the system and steal crypto funds. For instance, Pickle Finance, a decentralized finance (DeFi) protocol, was hacked in 2020 and lost about $20 million.

Regulatory Risk

The crypto industry is still facing scrutiny from governments as no clear regulations for crypto assets currently exist. Many governments fear that the unregulated nature of the industry may encourage illegal activities, thus requiring regulation. So, they are currently devising ways to regulate the industry. You have probably heard of lending platforms such as BlockFI that have received cease and desist orders. Therefore, it is still unclear how the suggested regulations might affect the crypto industry and your investments.

What is Staking?

Staking is the locking up of digital assets in a blockchain network to help validate transactions and secure the network. Investors are paid interest depending on the amount staked.

How Does Staking Work?

Unlike Bitcoin, which uses Proof of Work (PoW), staking is used by blockchains that apply the Proof of Stake (PoS) consensus mechanism. A PoS mechanism does not require much energy to run. So, it’s cheaper and simpler than its PoW counterpart. This mechanism also uses validator nodes to process transactions, which is more energy-efficient.

You can make money staking by being a validator or staker. To be a validator, you need technical skills to operate validator nodes. It’s also time-consuming, making it a less viable option if you are looking for an easy way to make passive income.

Crypto platforms allow you to stake assets and then leave the technical part to them. That way, you can make money without handling any tasks. You can stake assets on platforms such as Coinbase, Kraken, and Binance.

Top Crypto Assets to Stake

Crypto platforms offer many staking cryptocurrencies to choose from. However, their interest rates vary. Therefore, checking out different options will help pick the most profitable one. Here are some of the most popular and best cryptos for staking:

  • Solana (SOL)

  • Ethereum (ETH)

  • Cardano (ADA)

  • Polkadot (DOT)

Risks of Staking

Volatility Risk

Volatility is a huge risk that stakers face because if the invested asset enters a bear market, you might lose money. Therefore, you should not choose staking tokens based solely on annual percentage yield (APY). Always research the volatility too.

Lockup Periods

Most crypto platforms usually need you to lock assets for a certain period of time. So, you can’t access the crypto funds until the agreed period ends. Although this can be a good idea for earning consistent passive income, it could also be a trap. Why? If volatility increases, you can’t withdraw your assets from the market, hence guaranteeing a loss.

Rewards Duration

Crypto platforms have varying reward periods. Some pay rewards daily, while others only yearly. Investing with a platform that pays staking rewards yearly denies you the chance to reinvest regularly.

Loss or Theft

Most crypto platforms require you to set up a private key to secure your digital assets. However, if an unauthorized person accesses the private key, they can easily steal your assets. You could also lose crypto assets if your platform has unreliable security systems.

Yield Farming vs. Staking: The Differences

You have probably noted some differences between yield farming and staking by now. However, we will still discuss some of their major differences to make them clearer to you.

Let’s dive in.

Complexity

Staking is usually simpler than yield farming because all you have to do is look for a good staking pool and invest in it. Although, you do the same in yield farming, you might also need to regularly switch tokens or even platforms, which can be time-consuming. This can also be expensive since changing yield farming pools causes extra gas fees. Therefore, yield farming is more complex than staking.

Risk Level

Yield farming is pretty common on new crypto platforms, which increases the risk of rug pulls. Rug pulls are rare in established PoS networks, meaning it’s unlikely to experience them when staking. Also, staking requires less capital, making it a better option for risk-averse investors.

Impermanent Loss

Yield farming exposes you to impermanent loss. The loss could even be higher if you had invested in two volatile crypto assets. The loss is called "impermanent" because it’s only realized if you withdraw the assets. If you withdrew assets at a loss, you would have been better off holding them than investing in them. There is no impermanent loss in staking.

Profitability

Yield farming is riskier than staking but is more rewarding. Most staking rewards range between 5% and 14%. On the other hand, yield farming rewards can go up to 1,000%. For instance, PancakeSwap offers an APY of about 400%.

Duration

Staking forces you to lock funds for a prolonged period to earn rewards. Yield farming does not.

Security

Hackers fish for bugs in yield farming smart contracts to help attack the system. Therefore, yield farmers are more likely to experience security breaches than stakers. The PoS mechanism also makes staking more secure since a cybercriminal’s attempt to dupe the system may cause them to lose their staked assets.

See also: Staking vs. Mining.

Which One Is a Better Short-Term Investment?

Staking is an excellent short-term investment as it offers more steady returns than yield farming. Therefore, you can lock up crypto assets for the needed period and then withdraw them without reinvesting if you don’t want to.

Which One Is a Better Long-Term Investment?

Yield farming does not involve locking up crypto funds and allows you to diversify your portfolio. Therefore, you can easily shift between different platforms to ensure you always get the best deal in the market. This could enable you to make lots of money in the long term.

Although yield farming and staking have varying investing benefits, they can still be customized to fit a short-term or long-term strategy. For instance, you could stake your assets for longer periods, allowing you to use staking as a long term investment. Therefore, the option that fits your investing strategy is pretty individual.

Conclusion

Yield farming and staking are certainly great ways of putting idle crypto assets to work. However, you must first understand how they work before investing in them. Yield farming seems riskier but also highly rewarding. On the other hand, staking is less risky but also less profitable. Hopefully, this comparison has helped you determine your best fit.