Yield farming and staking are two popular investment strategies in the world of cryptocurrency. Both strategies have the potential for high returns, but they work differently and carry their own risks. It is important to understand the differences between yield farming and staking if you are considering investing in cryptocurrency so that you can make an informed decision about which strategy is best for you. This article aims to examine the meaning and the differences between yield farming vs staking as well as provide the pros and cons of both approaches to assist you in determining which one presents a more favorable investment option in the long run.
List of Contents
Yield Farming VS Staking: The Definition
What Is Yield-Farming?
Yield-farming is a common way to get more crypto assets by lending them out. The term comes from the idea that if you put your coins to work, their value will go up. So how does the method work?
Decentralized financial systems (DeFi) are the first step. These activities need a lot of cryptocurrency for trading, lending, borrowing, and blockchain transactions. But no one has enough real money or coins to make money appear out of thin air.
In return for clients’ coins, DeFi provides high-interest rates. The coins have become put into a “liquidity pool,” which is then using for lending, borrowing, and trading.
What Is Staking?
Staking is committing crypto assets to a blockchain network to support it and help validate transactions. Moreover, blockchain networks use the proof of stake (PoS) consensus algorithm. While they wait for their block rewards, investors earn interest on their assets.
Proof of stake (PoS) blockchains use less energy than proof of work (PoW) blockchains, like Bitcoin, because they don’t need as much computer power to verify new blocks as PoW networks do. Nodes are computers that process transactions, verify transactions, and act as checkpoints on a PoS blockchain. Validators are network users who set up nodes, are chosen at random to sign blocks, and are paid for doing so.
You might not even need to know how to set up a node technically, since crypto exchanges sometimes let investors can access their crypto assets, and the network takes care of building the node and getting it certified. Binance, Coinbase, and Kraken are examples of companies offering this service.
Since PoS consensus depends on who owns the coins, the initial distribution of coins to validators must be fair for the protocol to work. This can be done with the help of a trustworthy source or by showing proof of burn. Proof of stake is safe and utterly decentralized once staking has begun and all nodes are in sync with the blockchain.
Staking keeps attackers from breaking into a blockchain network—the more stakes on a blockchain network, the safer and more decentralized. In addition, stakeholders can make more money than investors in traditional financial markets because they maintain network integrity. Nevertheless, there are risks to staking because the stability of the network could change over time.
Yield Farming VS Staking: The Advantages
The Advantages of Yield Farming
Cryptocurrency yield farming is a way for investors to grow their holdings while making a coin better overall. If there is a lot of demand, interest rates may even go up once more money is added to the liquidity pool. Due to the currencies’ popularity, yield farming DAI or ETH could be a profitable business.
Investors can make money from dividends, transaction fees, interest, and price increases by using this passive investment strategy. And, unlike mining, yield farming doesn’t require any investment upfront besides the cryptocurrency you already have in your wallet.
The Advantages of Staking
The main advantage of staking is earning interest on your tokens.
Besides making money, staking also helps protect the ecosystem. As the last section showed, staking solves the problems plaguing the PoW consensus method. So, anyone can become an investor, even if they don’t have the best computer equipment or the most expensive power.
Yield Farming vs. Staking: What’s the Difference?
Which strategy is better for the average investor when choosing between yield farming vs staking? Yield farming and staking involve keeping a certain number of crypto assets to earn rewards.
Some investors believe that staking is part of yield farming. However, even though “yield farming” and “staking” are often used interchangeably, they are not the same in significant ways. Here are the most important differences.
1) Complexity
Yield farming and staking are both ways to make passive income, but staking is often the easier option because investors only need to choose a staking pool and lock up their cryptocurrency. On the other hand, yield farming might take some work since investors have to decide which tokens to lend and on which platform, and they can keep switching tokens or platforms.
As a yield farmer on a decentralized exchange (DEX), you may need to deposit enough of two currencies to provide liquidity. These could be anything from niche cryptocurrencies (e.g. NFTs) to stable coins with many users. Then, investors will get the reward based on how much money has been deposited. Even though switching between yield farming pools more often costs more gas, it is usually worth it. So, yield farming might benefit more from active management than staking. This is how farmers with the best crops can make the most money.
In the end, yield farming is more complicated than staking, but if you have the time, resources, and knowledge to handle it, you may make more money.
2) Risk Levels
When “rug pulls” happen, yield farming is often done on DeFi installations that have just been set up, which can be dangerous. This phrase is about developers taking assets out of liquidity pools.
Even smart contracts made by programmers with a lot of experience may have bugs or flaws, which is always a risk. A poll found that 40% of yield farmers can’t read smart contracts and don’t know about their dangers of them.
Staking doesn’t cost much to start, making it a good option for people new to DeFi. The chance of a rug pull on a PoS network that has been around for a while is also lower.
Volatility risk affects both yield farming and staking. When the price of tokens drops for no apparent reason, yield farmers and speculators may both lose money. Liquidation risk is also present when your collateral isn’t enough to support your investment.
Even though yield farming gives a higher return than staking, investors who don’t like taking risks may choose to stake over yield farming. Transaction costs can add up and cut into profits, increasing the risk. Asset depreciation is a risk with both strategies, and you could lose money if the market suddenly goes down.
3) Impermanent Loss
When investors yield farming, they could lose money temporarily because of changes in the price of the cryptocurrency since investors first deposited the assets. For example, if you put money into a liquidity pool and the cost of a particular cryptocurrency increases, you would have been better off keeping those tokens instead of putting them into the pool. As a result, if the value of your cryptocurrency goes down, you may lose this amount. On the other hand, the temporary loss doesn’t affect staking.
4) Profitability
When there is a risk, there may also be a benefit. In the same way that jumping off the Eiffel Tower for an adrenaline rush might not be a good trade-off (at least not without a parachute and a good lawyer), it is essential to weigh risk and reward when making financial decisions.
The main difference between yield farming and staking is the passive income investors can earn by staying invested. The more money made, the more it can be put back into the business and used to grow it. Albert Einstein famously called compound interest the “eighth wonder of the universe” because it can lead to significant returns.
A common way to measure returns is by the annual percentage yield (APY). Traditional staking on exchanges often gives more stable APY returns than yield farming. Most of the time, wagering returns are between 5 and 14 percent.
For example, yield farmers who join a new program or way of doing things early on might make a lot of money. CoinGecko says that the annualized rate of return can be anywhere from 1% to 1,000%. Even so, these methods carry a higher risk.
5) Duration
Yield farming is a better way for investors to get cash than staking. When investors keep their money in one place for a long time, staking gives them a higher annual percentage return (APY). On the other hand, you don’t have to invest any money in yield farming.
6) Inflation
PoS tokens are assets that cause inflation, and any returns to speculators are made up of new tokens. By staking your tokens, you might get benefits that are at least in line with inflation and are proportional to the amount you staked. If you don’t stake, inflation will cause the value of your current assets to go down.
7) Charges for services
For people who don’t know the difference between yield farming and staking, gas prices could be a big problem for yield farmers, who are free to move between liquidity pools but have to pay transaction fees. Even if yield farmers find they can make more money on a different platform, they still have to pay for switching.
In contrast to a PoW blockchain network, miners on this network do not have to solve complex math problems to earn rewards. As a result, costs for staking and maintenance are also lower.
8) Security
Yield farming based on more recent DeFi protocols may be easier to hack, especially if a smart contract’s code has bugs. Staking is often safer because participants participate in the underlying blockchain’s strict consensus mechanism. If someone tries to cheat the system, they could lose all the money they bet.
Yield Farming vs Staking: Which Is the Better Long-Term Investment?
With cryptocurrencies, you can also use yield farming and staking to make more money in the long run.
First, let’s look at yield farming, which means putting profits back into cryptocurrency to get more cryptocurrency as interest. Even though yield farming might not always give you an immediate return on investment (ROI), unlike staking, you don’t have to lock up your money to do it.
Even though there isn’t a quick payoff, yield farming could be very profitable in the long run. Why? Since there is no lockup, you can switch between platforms and tokens to find the best return. You just have to have faith in the network and DApp you are using. So, yield farming may be a great way to add variety to your portfolio.
Staking may also be an excellent way to make money in the long run, especially if you are committed to HODLing and want to keep your coins for a long time. Over time, your stake or yield farm may depend on how actively you manage your assets. Even if the returns from staking were lower, it would still be better than yield farming because the long-term risks are lower. This leads to more steady returns in the long run.
Conclusion
Compared to passive income strategies used in other financial markets, staking and yield farming are still reasonably new passive income strategies. However, the terms are often used interchangeably, and staking might even be considered yield farming. Both ways to make passive income depend on owning crypto assets to get paid, and each lets investors take part in the value of the decentralized financial ecosystem.
Staking may be more straightforward, but yield farming may require strategic moves to increase earnings. Both yield farming and staking have return rates that might be very enticing. Choosing between yield farming vs. staking depends on how much you know about investing and what is best for your portfolio.
FAQs
Yield Farming is a process of earning rewards by lending or staking cryptocurrency assets on decentralized finance (DeFi) platforms.
Staking is a process of holding cryptocurrency assets on a blockchain network to help validate transactions and earn rewards.
Staking may be more suitable for beginners as it is typically easier to understand and involves less risk. Yield farming can be more complex and requires a deeper understanding of DeFi platforms.
You will need to research and find a reputable DeFi platform that offers Yield farming or Staking, and then provide liquidity or stake your cryptocurrency. Always do your due diligence before investing.
Yes, there may be tax implications for earning rewards from Yield farming or Staking. It’s important to consult a tax professional in your jurisdiction for guidance.
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Read more: Cryptocurrency
Source: ByBit, Business 2 Community, The Economic Times