The term yield farming and staking are often used interchangeably, but the two are actually very distinct from one another. Find out which one is best for you here.

Yield Farming vs Staking

The high popularity of cryptocurrency has inspired people to start searching for passive income opportunities. Instead of letting the digital coins stay in the vault with the hope that their value will appreciate over time, investors have found a way to make use of them more effectively. There are many paths that can be taken to earn passive returns in cryptocurrency, but yield farming and staking are typically what people would go for.

 

What Is Yield Farming?

Yield farming is a service typically offered by decentralized exchanges (DEXs). The term "farming" originally referred to the idea of "growing your cryptocurrency" instead of letting it sit idly in a wallet. In order to earn passive income, users need to lend their digital tokens in a liquidity pool so it can add sufficient levels of liquidity on a specific trading pair and let other users interact with those tokens.

It can be used for several different purposes, such as lending, borrowing, and trading. In return for lending their tokens, the platform will reward users with interests collected from the trading fees paid by the pool users. The amount of interest they'll earn depends on their share percentage of the pool's total value.

For example, if you want to provide liquidity for the BNB/ETH pool, you'll need to deposit the same amount of BNB and ETH into the pool at current exchange rates. Every time someone uses your tokens, you will get a percentage of the trading fees. As a result, you can get passive income every now and then from your idle tokens.

Furthermore, yield farming is an essential part in the Automated Market Maker (AMM) system. AMM-based platforms offer permissionless and automated trading with the use of liquidity pools instead of the traditional order books. It can offer better liquidity, faster transactions, and lower trading fees.

 

Benefits of Yield Farming

Yield farming allows investors to grow their investments while also help adding liquidity and improve the overall performance of the coin. Yield farmers can make significant returns with low cost and take advantage from transaction fees, token rewards, price appreciation, and interest. The practice is even more profitable if the trading pair is currently in high demand.

With this method of passive investing, investors can earn daily interest and make better use of their spare coins. This can also be an inexpensive alternative to crypto mining because it doesn't require users to prepare supercomputers or pay for the electricity.

 

What Is Staking?

Compared to yield farming, staking is leaning more to the "technical" side because it aims to support the blockchain technology itself instead of boosting liquidity and providing lending services. The process is actually pretty similar: you need to commit a certain number of tokens in return for passive income. But instead of lending them to a liquidity pool, you should stake them to the network. It's also worth noting that unlike yield farming, staking has time limit. So, to get rewards, you must lock your tokens until the time period ends.

This method is used by blockchains with Proof of Stake (PoS) consensus mechanism such as Cardano and Solana. PoS is an alternative to the traditional Proof of Work (PoW) system, but it requires much less energy to operate. Instead of miners, the PoS system relies on "validators" to verify blocks and add them to the network. Each user has a chance to become a validator by staking their coins and set up nodes with their stakes. Then, a random node will be chosen to verify a block and the node owner will get a reward.

With that being said, staking can improve the blockchain's safety and make it more secure against attacks. The more coins staked on the network, the more decentralized and safer it will be. However, it's worth mentioning that there are risks involved with crypto staking as the network's stability might change over time.

 

Things to Consider in Crypto Staking

Staking crypto means you are dealing with Decentralized Finance (DeFi) platforms. By using smart contracts, these platforms aim to remove the use of intermediaries in order to reduce transaction costs and improve the safety of the network. Nevertheless, it's important to understand that not all DeFi platforms are great for staking.

Choosing the best DeFi platform might sound like a hustle, but you can quickly spot a good opportunity if you do the following things:

  • Consider the security of the DeFi platform. Do a small research and find out about the security level of the DeFi platform. It's also helpful to see the past performance of the platform.
  • See the liquidity level of the staking token. When it comes to crypto staking, it's best if you can get rewards as soon as possible. This can only happen if you stake in coins with high liquidity, so choose a coin that's on the rise or traded frequently.
  • Check if the rewards are inflationary. Crypto staking is not without risk, so make sure that you put your money in the right place. Try to look at a few different projects, then compare them and decide which one is the best for you.
  • Diversify into other staking projects. Like other investments, it's recommended to stake in multiple different projects at once to reduce the risks should one project face unpredictable problems.

 

The Difference between Yield Farming and Staking

Both yield farming and staking provide great solutions to earn passive income in cryptocurrency. Now that we already figured out the characteristics of each option, let's compare them and see what makes them different from one another.

 

Profitability

A common unit of measurement to figure out the rate of gains in an investment is called Annual Percentage Yield (APY). In this case, staking cryptocurrencies on exchanges typically have steadier APY compared to yield farming. Staking rewards usually ranges from 10-14% per year. On the other hand, yield farming can produce higher returns at times, but it presents higher risks and less steady.

 

Security

In terms of security, staking is considered safer than yield farming because the process takes place on a stable blockchain network with strict protocols and decentralized nature. Yield farming, however, is based on specific DeFi protocols that may be more vulnerable to hackers and external attacks, especially if there's an unknown bug or glitch in the system.

 

Complexity Levels

Generally, staking offers an easier strategy to earn passive income compared to yield farming. In staking, you only need to choose the coin, decide how much you want to stake, and lock them for some time. On the other hand, yield farming requires a bit of work as you must choose the token to lend and on which platform. After that, you still need to search for opportunities and you might need to switch pools for better rewards.

 

Investment's Duration

Yield farming certainly offers much higher flexibility when it comes to the duration of the investment because it doesn't have a minimum time limit. Meanwhile, staking requires users to lock their funds for a certain period of time in return for considerable APY.

 

Risk Levels

Both options are risky to a certain extent. Yield farming can be highly risky if "rug pulls" happen, which refers to shady developers that empty the liquidity pool in purpose. Staking, on the other hand, can also be risky because the network might have some bugs and technical difficulties at times. Furthermore, volatility is a common occurrence in both yield farming and staking. Investors can easily lose money if the price drops unexpectedly. Apart from that, liquidity risk is also present if the collateral is not enough to cover the investment.

 

Impermanent Loss

Impermanent loss is a risk that is unique to yield farming. It refers to the possibility of getting loss due to price fluctuations that happen in the pool compared to the actual market price. Suppose that you store your coins in a pool and the price of that coin spikes up, you would have been better off holding those tokens instead of investing them in yield farming. A similar situation could also happen when the price drops in value.

 

Transaction Fees

The cost of staking is generally lower than yield farming. In yield farming, you have the freedom to switch between liquidity pools, but you need to pay transaction fees every time you do it. So, apart from calculating the returns, you also need to consider the switching fees. Meanwhile, staking only requires investors to pay for transaction fees upfront and maintenance cost.

 

Inflation

Remember that PoS tokens are inflationary assets, so they are affected by the price inflation. By staking your coins, you can either receive rewards or lose some of your staked holdings in line with inflation.

 

So, Which One Is Better?

On a concluding note, we can see that both yield farming and crypto staking have specific benefits and drawbacks. On one hand, yield farming offers higher returns and flexibility, but it requires more work and is more risky. Therefore, it is more suitable for active short-term investors with sufficient knowledge about trading. They need to plan their actions and must regularly update their investments to get maximum profit.

On the other hand, crypto staking is more suitable for beginners because it is easier to understand and doesn't require a lot of funds to begin with. Staking also offers a more steady income and less effort.

With that being said, both strategies can be an attractive option to increase the profitability of your assets. However, you need to pick the one that suits your trading style and interests the most in order to get maximum advantage. Keep in mind that each strategy has its own risks, so make sure to do a thorough research before investing.