What are the differences between Staking, Liquidity Mining & Yield Farming?
The terms staking, liquidity mining, and yield farming are often (unknowingly) confused or misused.
Whilst each of these terms implies that a user earns compensation by making their assets available for a limited time in order to support an economic function, the underlying nature of these terms differ.
“Staking” in particular generates many questions because it is used in various reward model types which no longer correspond to the historical definition in Crypto.
The commonalities of staking, liquidity mining, and yield farming are obvious, users are financially rewarded for supporting something.
The first thing that semantically distinguishes between these terms is the entities that actually pay out the reward.
A Staking Reward Program may pay out rewards to users for providing liquidity to DEX pools above and beyond the rewards already paid by a DEX. The entity here would be a company looking to hedge its existence.
In the case of lending, the initiator of reward payments is not a DEX or a crypto company like DePay, but a DeFi lending protocol.
The second factor that makes these terms non-interchangeable is the motivation of the entity for paying out the rewards/earnings. You are generating value to the reward payer in each case, which is something that you should be aware of. This can be, for example, network security that you increase for a protocol, ensuring the base of its business model (liquidity provision by users), or providing missing capital for a startup with its own reward model.
Therefore, before you provide DEPAY/ETH liquidity and earn passive income in the form of rewards, we would like to clarify important terms so that you better understand what exactly you are being rewarded for.
What is Yield Farming?
Yield farming is a generic term. It describes the act of making your own liquidity available for a certain period of time (“locking”) and earning a variable reward (based on the size of your stake). Yield farming in DeFi can be done in several ways. The most common are lending and providing liquidity on decentralized exchanges like Uniswap.
What is Liquidity Mining (or Liquidity Staking)?
Liquidity Mining is often used synonymously with yield farming. In fact, liquidity mining is only a subcategory(child) of yield farming.
Decentralized Exchanges consist of pools of different currencies (e.g. DEPAY/DAI). It is in the interest of the DEX and its users that trades can take place smoothly. This means that someone who wants to buy an asset should be able to meet a seller.
Similarly, sellers should always be able to meet willing buyers so that uninterrupted trading with high volumes is possible. In addition, with automated market makers such as Uniswap, large price changes can occur at the execution of a trade.
If an initiated trade is significant in size relative to the total pool liquidity, the slippage can also be significant. This means that the expected (original spot) price can change significantly at execution time to the trader’s disadvantage. This influence of large trades can only be counteracted if there is sufficient liquidity within a pool.
To ensure that traders’ needs are always met, DEX’es like Uniswap reward their users for filling pools with liquidity and serving as so-called “Liquidity Providers” (LP’s).
As a LP, your contribution earns you a portion of the fees paid by buyers and sellers on each trade, measured proportionally to the total liquidity pool. “Liquidity mining” is sometimes referred to as “liquidity staking.” “Staking,” however, is a term with a high potential for confusion. The next sections describe why this is so.
What is Staking?
It is interesting and helpful in understanding the different uses of the term to consider its use outside the crypto world:
- “I will vote as a stakeholder” means your stake might give you certain rights, such as governance-related ones.
- “I have a stake in/of” might mean that you own a financial share of something
- “I’d stake my car on it.” = In this case, “stake” means you are taking on a risk due to your belief in something. If your conviction is not based on research and facts, you’re actually gambling. Which brings us to poker:
- In poker, your stake (or buy-in) is the amount of money you’re willing to gamble with in a session
- “My job is at stake” means you will lose your job if you fail at something. It implies high risk.
- “I staked the young team of researchers with a new microscope” means that you enable someones work in pursuit of a goal with your (financial) support.
- Young trees “require a stake” to grow safely. You stake newly planted trees to stabilize them and support their growth. What’s in for you? Probably some juicy fruits!
We can see that the following aspects are often implied:
- Possible increase in rights and influence
- Possible gain as risk compensation
- Increase of security: support for growth or achievement of goals with financial means or actions
In particular, before the start of the DeFi boom, the use of the term “staking” had the meaning that you (the “staker”) take on the role of a validator in a network in the context of a “proof-of-stake” (POS) mechanism’ to increase network security as a staking participant.
Depending on the underlying technology, even today, this process can look different and often requires good technical understanding. In a POS-based system, the more people who participate in the proof-of-stake consensus with confirming transactions and adding new blocks, the more efficiently and securely the network operates. The motivation to reward you for doing this is to secure the present and future of the particular technology you are staking on. You make available to the network some of your assets in POS Staking and earn a certain amount of reward coins for the value you create (network security).
In POS Staking, the barriers to entry are not limited to technical knowledge (such as server administration/docker/programming languages to set up so-called “nodes”). Often a minimum amount of asset or even investment in infrastructure is required, which not every average crypto user wants or is able to bear.
In the DeFi context, you will often come across articles talking about a different kind of “staking.” Let’s shed some light on the staking darkness.
What is Staking in DeFi?
The term “staking” is frequently used today, especially in DeFi, without a POS mechanism being involved.
Most often, Liquidity Staking is equated with Liquidity Mining in these cases. However, as described in the introduction of this article, the entities and their motivations for paying out staking rewards are not always the same when “staking” is mentioned.
The reason why the term likes to be used universally might be the expectation:
“When I stake an asset, I make it available to someone else for a period of time and am subsequently rewarded for it. I earn passive income”.
This expectation is legitimate, as it is fulfilled in most cases.
However, if you are looking to earn passively within the crypto space for the first time through “staking,” we recommend that you do some research beforehand in order to understand what “value” you are generating with your capital. It would be wise to understand the risks involved and whether the associated reward is justified (e.g. “impermanent loss” when you lock up assets for a long period).
Uniswap v3: A Liquidity Mining Revolution
Since Ethereum gas fees have skyrocketed to new heights due to the popularity of the blockchain, providing liquidity has also become less and less attractive.
Uniswap has put a strong focus on making liquidity staking “sexy again” with v3 by lowering the risks associated with it (among other great things).
Due to the new paradigm of “concentrated liquidity,” even small but strategically well-considered positions of provided liquidity can now earn way more rewards than large positions that are spread across the entire price spectrum (which was the default in v2).
Tip: Learn how to earn passive reward income on Uniswap v3
If you want to understand how you can earn passive income on Uniswap v3 with lower risk and capital investment compared to v2, you should take a look at our article about how to earn your stake of pool trading fees as a liquidity provider on Uniswap v3. You might just be surprised what Uniswap v3 has to offer!