Staking or Liquidity Providing: Which is Right For You?
Staking and liquidity providing are the easiest and most effective ways to make money with your cryptocurrency with lots of people already enjoying passive income through those practices. But are they safe? Is one better than the other? What are their pros and cons?
In this article, we’ll tell you all about staking and liquidity providing, and provide practical examples.
What is liquidity providing?
Liquidity providing is the process of adding value to a liquidity pool. Liquidity pools are collections of digital funds locked in a smart contract. Anyone can add liquidity to a pool to become an LP (liquidity provider). This is possible due to AMM (automatic market-making), which acts similar to ordering books in centralized markets.
What is staking?
Staking is a way for you to put your cryptocurrency to use without selling it outright. Staking is like storing money in a savings account. When you put money in a savings account, you plan to let it sit there for a while. When you stake crypto, you are locking up tokens for a certain period to earn rewards. Although figures vary between projects, staking usually offers over 10% APY, while savings accounts at banks rarely exceed 0.5 percent.
APY is the expected interest you will earn from staking a certain token amount. Some projects also offer their tokens as a staking reward. By staking the token for a certain period, you earn another token from the same project.
Your tokens will be locked up (unavailable for use) while staking. So you won’t be able to sell them if their price drops. That brings up another con, market swings. Like any market, the cryptocurrency market is unpredictable. Prices can change at a moment’s notice. Because of this unpredictability, staking is a higher risk than traditional banking activities.
What is better: staking or liquidity providing?
Staking and liquidity providing are both DeFi (decentralized finance) trading methods. At face value, one isn’t better than the other, it depends on your financial strategy.
Staking is a better long-term DeFi strategy because many projects don’t have a required staking period. This means that you can keep tokens staked as long as you like, indefinitely even, while reaping rewards simultaneously.
Anyone who stakes can earn a high APY, or interest, on their stake. Many projects also offer their tokens as rewards. The biggest benefit to staking is the ability to earn a passive income. Staking lets you sit back and relax while your tokens do the work for you. Staking is also a great way to support the projects you love. It strengthens their token and gives the project more legitimacy. Finally, it aligns network security with user incentives, rewarding users for staking in proof-of-stake protocols.
On the other hand, the most obvious plus of liquidity provision is that it’s decentralized and open for anyone to use. Liquidity provision also allows for more DeFi exchange opportunities, like liquidity mining. In liquidity mining, users pool their tokens and earn rewards in newly minted tokens as per the smart contract.
Liquidity providing is a high risk, high reward DeFi activity. Anytime you provide liquidity to an AMM, there is a risk of impermanent loss. This means that your tokens lose a certain amount of value when you use them to provide liquidity instead of storing them in your wallet. What’s more, the token price could change between the time it was placed and when it was executed. This is known as price slippage.
Also, there are no third parties guaranteeing your funds’ safety, only the smart contract. If the smart contract is faulty or gets hacked, then you could lose your funds.
Lastly, you need to be careful of dishonest projects. Scam projects could change the smart contracts once liquidity providing has already begun, and steal your funds. Be sure that any liquidity pools you take part in have their smart contracts audited.
If you feel comfortable taking big risks, then you might want to check out liquidity providing. If not, better to leave it alone at this stage in your crypto journey.
What are the pros and cons of staking?
- high APY
- simple process
- earn tokens as rewards
- great way to earn a passive income
- support the projects you love
- locked-up tokens
- higher risk than banking
- market swings
Let’s say you wanted to stake on Everstake as one of the major validators in the ecosystem. Once you have your wallet set up and funded, you can choose which tokens you want to stake: we’ll use Elrond tokens (EGLD) in this example. The minimum staking amount for Elrond is 1 EGLD. If you were to stake 1 EGLD on Elrond, you would be charged a fee of 0.00018138 EGLD. Staking fees are inevitable, but the rewards are well worth it! You can earn approximately 12.1% APR from stakes. At that rate, the 1 EGLD you staked would earn you 0.121 EGLD.
What are the pros and cons of liquidity providing?
- Liquidity mining
- Impermanent loss
- Smart contract risk
- Dishonest projects
- Price slippage
Now let’s say we wanted to provide liquidity to Elrond tokens. We need another token to make a token pair, we’ll use MEX to make an EGLD/MEX (Maiar Exchange) liquidity pool.
The proportion of token pairs in a liquidity pool must always be 50/50. So if we want to add 1000 USD liquidity and EGLD is worth 250 USD and MEX is worth 0.10 USD, we should add 2 EGLD and 5000 MEX. Using an AMM, we swap that 2 EGLD for MEX. Once finished, we can add our token pair to the pool to create liquidity. The liquidity we added gives us LP tokens, in this case, LP-EGLDMEX. LP tokens give us a share in the pool. More on liquidity provision on Maiar DEX is available here.
As DeFi continues to evolve, there are more and more ways you can earn with crypto. Staking and liquidity providing are two of the most fundamental, and profitable, options. For those looking to make a quick turnaround, staking is probably the best option.
Subscribe to social network updates from Everstake where you will find more guides on staking and useful articles about PoS networks!