Yield Farming vs. Staking: Which One Is Better?

Yield Farming vs. Staking

Yield farming and staking have many similarities, and they are both excellent methods to generate a passive income as a crypto holder. Understanding the differences between these two approaches is essential for investors looking to maximize their returns while managing risk effectively.

Staking is when crypto investors lock up their funds to support a blockchain or protocol and earn a percentage on the fees collected or receive a stipend of newly issued tokens or coins. This process helps secure the network and validate transactions, rewarding participants for their contribution to the blockchain's security and stability.

Yield farming is when users stake their crypto funds on DeFi platforms and take their liquidity provider tokens to stake again on other platforms to multiply their returns. This strategy involves a more active approach to maximizing yields by leveraging multiple protocols and opportunities across the decentralized finance ecosystem.

What Is Staking?

Staking is like purchasing treasuries or a government bond. When you purchase a bond, you are lending the government money, which they pay back through taxation or printing more currency. This analogy helps illustrate the fundamental concept of staking as a form of investment where your assets work for you over time.

Similarly, when you stake, you are putting your crypto into a smart contract and, in the case of blockchain staking, earning a portion of the transaction fees and earning newly minted cryptocurrency. Blockchains that allow staking use a proof-of-stake mechanism, which represents a more energy-efficient alternative to traditional mining.

PoS is an alternative to the PoW (Proof-of-Work) mechanism. Instead of mining, validators stake their crypto to generate new blocks. The process of staking is far less energy-consuming, making it an environmentally friendly option that has gained significant traction in recent years. This shift toward PoS has been driven by concerns about the environmental impact of cryptocurrency mining and the desire for more sustainable blockchain solutions.

How Does Staking Work?

Users are required to stake either a fixed amount of crypto to become validators or they can participate in liquidity pools. Each staking platform may have slightly different rules; the most common way is using staking pools, which allow smaller investors to participate without meeting the high minimum requirements for solo validation.

Staking typically involves locking your crypto funds, akin to a crypto savings account, and necessitates an investment in cryptocurrency. In many cases, staking mechanisms will slash your crypto funds if you behave maliciously against the blockchain network. This slashing mechanism serves as a deterrent against fraudulent behavior and ensures that validators have a financial incentive to act honestly.

Each liquidity pool comes with its own conditions and APYs (Annual Percentage Yields), which represent the annual income potential for that specific pool. These yields can vary significantly based on factors such as the total amount staked, network activity, and the specific blockchain protocol being used.

To sum things up, you can stake crypto on both blockchains and decentralized applications for different purposes. However, the key takeaway is all staking mechanisms, whether blockchain or DApp-based, require users to lock up their crypto to earn. This lock-up period can range from a few days to several months, depending on the platform and the specific staking arrangement.

How to Stake PoS Cryptocurrencies

Staking is easy, and it can be done with any relevant cryptocurrency. Only cryptocurrencies native to a Proof-of-Stake mechanism can be used for staking. This limitation is important to understand, as not all cryptocurrencies support staking functionality.

The most common ways to stake crypto are:

1. Using a wallet: Many cryptocurrency wallets now include built-in staking functionality, making it easy to stake directly from your wallet interface.
2. Using a crypto exchange: Major crypto exchanges offer staking services, providing a convenient option for users who already hold their assets on these platforms.
3. Participating in a staking pool: Staking pools allow multiple users to combine their resources, making it possible to participate in staking with smaller amounts of cryptocurrency.
4. Becoming a validator: For those with sufficient technical knowledge and capital, running a validator node offers the highest potential rewards.

The most common steps for staking cryptocurrency are:

• Set up a crypto wallet for staking.
• Transfer your crypto funds to that wallet.
• Decide on one staking pool.
• Lock your funds for staking.
• Wait to collect your staking rewards.

Cold wallet staking is also available. This offers maximum protection for your staked funds, as there is no internet connection, significantly reducing the risk of hacking or unauthorized access to your assets.

Ethereum allows staking. You can become a validator if you have 32 ETH and the technical knowledge to set up a validator node. Or you can use a major crypto exchange to stake Ethereum, which provides a more accessible option for those who don't meet the minimum requirements or lack the technical expertise for solo staking.

Cardano is already well-known for its wallets used for staking ADA. It only requires a wallet connected to the network, and staking begins immediately. Cardano's user-friendly approach to staking has made it a popular choice for investors seeking a straightforward entry into passive income generation.

Top 5 Cryptocurrencies for Staking

These are the most staked cryptocurrencies, representing some of the most established and reliable options for investors:

• Ethereum: As one of the largest blockchain platforms, Ethereum offers substantial staking opportunities following its transition to PoS.
• Cardano: Known for its research-driven approach and user-friendly staking mechanism.
• Tezos: A self-amending blockchain that offers competitive staking rewards.
• Polygon: A layer-2 scaling solution that provides attractive staking yields.

Each of these cryptocurrencies has its own unique features and staking requirements, making it important for investors to research and understand the specific characteristics of each platform before committing their funds.

What Is Yield Farming?

Yield farming is the DeFi version of rehypothecation, a practice where financial institutions re-use collateral to secure a loan or other obligations. This concept has been adapted to the decentralized finance space, allowing crypto holders to maximize their returns through strategic deployment of their assets.

The process of yield farming is pretty basic. Crypto holders can use a lending platform, such as Compound or Aave, or they can provide liquidity directly on DEXs, such as Uniswap or PancakeSwap. These DeFi platforms allow users to earn interest on their assets, creating opportunities for passive income that can significantly exceed traditional staking rewards.

Users need to deposit their funds on one of these platforms and receive an APY and the platform's LP token, which in turn can be used to deposit or stake on another DeFi platform. This layering strategy is what gives yield farming its potential for high returns, as users can compound their earnings across multiple protocols.

If you prefer to use a DEX, you will need to provide a pair of coins, according to the available liquidity pools. Each liquidity provider will receive a percentage of the rewards of the pool, according to the amount provided. This proportional distribution ensures that larger contributors receive correspondingly larger rewards.

The passive income for yield farmers comes from the interest rate paid by the borrower or the users of the liquidity pool, in the case of the DEXs. Yield farming is deemed more reliable than crypto trading, as it generates returns based on providing essential services to the DeFi ecosystem rather than speculating on price movements.

Yield farming has been around since 2020 when Compound — the first DeFi lending protocol — was launched. Since then, the practice has evolved significantly, with numerous platforms and strategies emerging to serve the growing demand for DeFi yield opportunities.

How Does Yield Farming Work?

Yield farming uses smart contracts or automated market makers to facilitate crypto trading. Liquidity providers deposit funds to the liquidity pool to sustain the system, and they earn a reward for it. This system creates a symbiotic relationship where liquidity providers enable trading activity while earning fees from that activity.

Because of the liquidity providers who offer their funds to certain liquidity pools, other users can lend, borrow, and trade crypto. All crypto transactions have a service fee, which is distributed among the LPs. This fee structure incentivizes liquidity provision and ensures that the platforms remain liquid and functional.

Besides that, all lending protocols have a native token distributed to the LPs to incentivize liquidity pool funding further. These token rewards can represent a significant portion of the total yield, especially for newer platforms looking to attract liquidity and grow their user base.

Liquidity Providers and Liquidity Pools

The liquidity is managed by the AMM system, and the liquidity pools and the liquidity providers are the two main components. Understanding these elements is crucial for anyone looking to participate in yield farming.

Basically, it is a smart contract that collects funds to facilitate crypto users to lend, borrow, buy, and sell cryptocurrency. Those who deposit funds into liquidity pools are called liquidity providers and use their funds to power the DeFi ecosystem. They earn incentives from the liquidity pool, which can include both trading fees and platform token rewards.

Liquidity pools operate on mathematical formulas that determine pricing based on the ratio of assets in the pool. This automated pricing mechanism eliminates the need for traditional order books and enables continuous trading even in markets with lower trading volumes.

Best Yield Farms

As with any system, yield farmers support the system because they earn an incentive from the platform they use. The best yield farms are usually the ones that are most secure and provide the highest yields. However, it's important to note that higher yields often come with higher risks, and investors should carefully evaluate the security and sustainability of any platform before committing funds.

Bake (ex. Cake DeFi)

Yield aggregator

Blockchain: DeFi Chain ROI: Up to 30% Assets: 25+

Bake is a platform that covers all your DeFi needs. It's designed to be user-friendly and help you earn more. The available products include Staking, Borrowing, Yield Mining, and YieldVault. This comprehensive approach makes Bake an attractive option for investors looking for a one-stop solution for their DeFi activities. The platform's focus on user experience has helped it attract a growing community of users seeking accessible yield farming opportunities.

PancakeSwap

DEX

Blockchain: Ethereum, BNB, Polygon, and Aptos ROI: Up to 59% Assets: 50+

PancakeSwap is a DEX that is based on the BNB Chain. It works similarly to other automated market maker platforms in that it allows users to trade cryptocurrencies directly from their digital wallets, eliminating the need for intermediaries. PancakeSwap has become one of the most popular DEXs due to its low fees, fast transactions, and wide variety of liquidity pools. The platform's multi-chain support has further expanded its reach and utility.

Yearn Finance

DeFi protocol

Blockchain: Ethereum ROI: Up to 50% Assets: 70+

Yearn Finance is a DeFi protocol that aims to optimize yield generation for crypto assets. It provides an automated platform that helps users find the highest yield opportunities across various lending and liquidity protocols. Yearn's innovative approach to yield optimization has made it a cornerstone of the DeFi ecosystem, automatically reallocating funds to maximize returns while managing risk.

Curve Finance

DeFi protocol

Blockchain: Ethereum ROI: Up to 40% Assets: 71+

Curve Finance is a DEX protocol designed specifically for stablecoin trading. It focuses on providing low-slippage and low-fee transactions for stablecoin swaps, making it ideal for stablecoin traders and liquidity providers. Curve's specialization in stablecoin trading has created a unique niche in the DeFi space, offering more efficient trading for assets with similar values.

What Are the Risks of Yield Farming?

Collateral Liquidation

When a user wants to borrow crypto, they have to deposit collateral on the lending platform, which will cover the loan. Some lending protocols require as much as 200% of the value borrowed to be deposited as collateral. This over-collateralization requirement is designed to protect lenders but can create significant risks for borrowers.

If the deposit or collateral suddenly plummets in value, the pool will try to recuperate the loss by selling the collateral on the open market, but there still can occur a loss of value, which leaves the liquidity providers exposed to loss. This liquidation process can happen rapidly during market downturns, potentially resulting in significant losses for those who have borrowed against their assets.

That's why it is better to borrow from a high ratio collateral pool, to avoid collateral liquidation, in case the price of an asset drops. Maintaining a healthy collateralization ratio and monitoring market conditions are essential practices for managing this risk.

Price Fluctuations

The crypto market is very volatile. Yield farmers can experience loss when tokens suddenly lose value. This can happen when certain trends make the market buy or sell certain tokens. The phenomenon known as impermanent loss can occur when the price ratio of tokens in a liquidity pool changes significantly, potentially resulting in losses compared to simply holding the tokens.

Price volatility affects not only the value of the tokens being farmed but also the value of the rewards earned. Sharp price movements can quickly erode gains or amplify losses, making risk management and diversification crucial strategies for yield farmers.

Protocol Glitches

Yield farming and the entire DeFi ecosystem rely on smart contracts to facilitate all financial operations. A poorly designed protocol or smart contract can lead to hacker attacks or other malfunctions, which leads to the loss of funds. The history of DeFi includes numerous examples of smart contract vulnerabilities being exploited, resulting in millions of dollars in losses.

Due diligence is essential when choosing yield farming platforms. Investors should look for platforms that have undergone thorough security audits, have a track record of secure operations, and maintain insurance funds or other protective measures. Even well-audited protocols can have vulnerabilities, so diversifying across multiple platforms can help mitigate this risk.

Yield Farming vs. Staking: Which One Is Better?

Whether yield farming or staking, each method demands a different level of expertise. Yield farming might seem more lucrative regarding potential returns, but it requires a deeper understanding of the crypto market. It often involves more complexity and demands consistent attention and research, making it challenging for new crypto investors.

On the other hand, staking offers a simpler, more hands-off approach. While the rewards might be lower than yield farming, it doesn't require constant monitoring, and investors can lock in their funds for longer periods. The choice ultimately depends on the type of investor you are and your experience level in the DeFi space.

For beginners, staking typically represents a more suitable entry point into earning passive income from cryptocurrency. The predictable returns, lower complexity, and reduced risk profile make it an attractive option for those new to the space or those who prefer a more conservative investment approach.

Experienced investors with a higher risk tolerance and the time to actively manage their investments may find yield farming more appealing. The potential for significantly higher returns can justify the additional effort and risk, particularly for those who have developed expertise in identifying profitable opportunities and managing the associated risks.

Ultimately, many sophisticated investors employ a combination of both strategies, using staking for a stable base of returns while allocating a portion of their portfolio to yield farming for higher potential gains. This balanced approach can help optimize returns while managing overall portfolio risk.

FAQ

What is Yield Farming and how does it generate returns?

Yield Farming is earning rewards by providing liquidity to DeFi protocols. It generates income through interest, governance tokens, or transaction fees from the protocol.

What is Staking, and how does it differ from Yield Farming?

Staking locks cryptocurrency to secure blockchain networks and earn rewards through validation. Yield Farming provides liquidity to DeFi protocols for rewards. Staking focuses on network security; Yield Farming maximizes returns through liquidity provision.

Yield Farming和Staking哪个风险更高？

Yield Farming风险更高。它依赖于多个协议的表现，存在智能合约漏洞风险。Staking通过锁定代币获得稳定回报，风险相对较低。

What are the typical expected annual yields for Yield Farming and Staking?

Yield Farming typically generates annual returns of 20% to 200%, while Staking usually produces 5% to 14% annually. Yield Farming offers higher returns but carries greater risk, especially with newer projects. Staking is more stable and suitable for long-term investors seeking consistent passive income with lower volatility.

Should beginners choose Yield Farming or Staking?

Beginners should start with Staking. It is simpler, requires less technical knowledge, and offers more stable returns with lower risk compared to Yield Farming, which involves complex liquidity provision and impermanent loss exposure.

What is Impermanent Loss (IL) in Yield Farming?

Impermanent loss occurs when cryptocurrency price fluctuations cause your liquidity pool assets to underperform compared to simply holding them. It happens when the ratio between two pooled assets changes significantly, resulting in potential losses that become permanent only when you withdraw.

Staking需要锁定多长时间才能获得收益?

Staking lockup periods vary by platform. Most require 7-30 days minimum, with common options at 14 or 21 days. Some platforms offer flexible staking without lockup periods but with lower yields. Choose based on your liquidity needs and desired returns.

How much initial capital do I need to start yield farming?

Yield farming typically requires a minimum of $1,000 to $5,000 in initial capital to begin. The exact amount varies depending on the platform and strategy you choose. Higher initial investments generally allow for greater potential returns.

How to assess the safety and sustainability of yield farming projects?

Evaluate smart contract audits from reputable firms, monitor total value locked and liquidity trends, assess token emission rates and vesting schedules, review governance structures, and check insurance coverage or risk mitigation mechanisms in place.

What is the source of staking rewards and why are projects willing to pay these rewards?

Staking rewards primarily come from token inflation and transaction fees. Projects distribute rewards to incentivize network participation, secure the blockchain, and increase token holder engagement, thereby building a stronger ecosystem and community.