Defi Yield Farming vs Staking: What’s the Difference.
Defi has created multiple opportunities for crypto investors by offering innovative ways to earn passive income in the blockchain ecosystem.
Yield farming and staking are great examples of such methods and we will explore what they are and how they differ in this article.
What is Yield Farming
Yield farming, also known as liquidity mining, involves providing liquidity to decentralized exchanges (Dex) or lending platforms in exchange for rewards.
Yield farmers (liquidity providers) typically lend their assets to liquidity pools, which are pools of funds that are used to facilitate trading on decentralized exchanges and earn rewards for providing liquidity to these pools.
These rewards can be in the form of interest payments, trading fees, or governance tokens. The primary goal of yield farming is to maximize returns and yield farmers move their assets across multiple Defi protocols to take advantage of yield opportunities.
Basically, it's like regular farming. (Hear me out)
You plant your seeds (assets) in the soil (Dex) and after a while, you can come back to harvest fruits (rewards) from time to time. Do you get it?
Yield farming allows you to earn passive income from your assets instead of just letting them sit in your wallet.
You can check out this article for a more detailed explanation. Now let's see how it works.
How Yield Farming Works
In yield farming liquidity providers deposit their assets in the liquidity pool of Defi protocols. The liquidity provided allows the Defi protocol to function and users pay fees when they interact with the platform.
A certain percentage of these fees are given to the liquidity providers as a reward and as an incentive to encourage more liquidity provision.
Apart from earning a percentage of the protocol's fees, liquidity providers can also be given interest tokens that accrue interest over a period of time.
For example, if you deposit Eth in Aave (a lending platform) you receive a tokens (an interest token) which allows you to earn interest and can be redeemed later.
For a more practical example let's say you deposit 10 ETH on Aave you get 10 aETH (interest token). Let's assume the interest rate is 10% per month, which means at the end of the month you'll have 11 aETH tokens which will be 11 ETH when you redeem it.
Yield farming can prove profitable if you have a good understanding of the Defi protocols mechanics.
What is Staking?
Staking refers to locking your crypto on a Defi protocol for a certain time to earn rewards. The locked crypto helps support the operation of the blockchain network.
Users lock their cryptocurrency holdings in a smart contract on a Proof of Stake (PoS) blockchain which allows them to contribute to the governance of the blockchain and earn rewards over time.
So what differentiates Yield farming from staking?
Yield Farming vs. Staking
Yield farming and staking are similar but completely different.
While yield farming involves providing liquidity to decentralized exchanges to earn rewards, staking on the other hand involves locking your crypto on a blockchain network to receive rewards.
While both methods involve holding assets, yield farming focuses on providing liquidity to DeFi platforms, whereas staking focuses on network security and governance. Also, rewards from Yield farming are typically higher than staking rewards.
You can also check here for more information on the difference between Yield farming and Staking
Now, there are a few risks involved in Yield farming.
Risks
Staking is less risky when compared to yield farming. Even though yield farming is very lucrative it is still very risky and yield farmers are exposed to some risks, including:
- Rug pulls
This is a scam where the owner of the Defi protocol abandons the project and steals users' funds.
It is important to do in-depth research on the protocol before investing.
- Smart contract Hacks
Hackers can exploit vulnerabilities in smart contract code and steal funds deposited by users.
Smart contract audits can help Defi protocols spot these vulnerabilities early and improve smart contract security.
- Impertinent loss
The value of assets in liquidity pools can fluctuate significantly, leading to potential impermanent loss which occurs when the value of one asset in a liquidity pool rises significantly compared to the other.
This means you end up receiving fewer assets than you initially contributed.
Conclusion
Yield farming and staking are two ways to earn passive income in the Defi ecosystem.
Both yield farming and staking have their merits, and the choice between them depends on individual preferences, risk tolerance, and investment goals.
If you're interested in Defi then you'll want to know why Web 3 is the future of the internet, get started here
