The decentralized finance industry (DeFi) offers many ways through which you can earn interest on your idle digital assets. At the forefront are yield farming and staking.
In this guide Yield farming or staking cryptocurrencies explain how each DeFi investment product works so you can make an informed decision about which one is right for you.
What is Yield Farming?
Yield farming is a service offered by decentralized exchanges (DEX). The main concept is that you lend your digital tokens to the DEX so that it can offer buyers and sellers a sufficient level of liquidity on a specific trading pair.
✓ Pair / single token
✓ Suppose, for example, that DEX offers a BNB/ETH trading pair.
✓ To swap BNB for ETH or ETH for BNB, enough liquidity must be available to cover the exchange.
This is where yield farmers come into play. To make money on their tokens, one would need to deposit the same amount in BNB and ETH. For example, $1,000 in both BNB and ETH at current exchange rates.
As long as your BNB and ETH tokens feed into the BNB/ETH liquidity pool on the selected DEX, you will earn a percentage of the trading fees. These are the fees that buyers and sellers pay to access a given trading pair on the DEX.
As a result, yield farming offers a great way to offer Passive income from idle cryptocurrencies. However, you will need to have access to both tokens from the trading pair to ensure liquidity.
What is staking ?
The main difference between staking and yield farming is that the latter requires two individual tokens to create a single trading pair - like BNB/ETH.
However, in the case of cryptocurrency stakings, you are required to lend only one token to the corresponding exchange.
✓ Before we get to that, we should note that staking in its original form involved locking up your tokens in a Proof-of-Stake (PoS) blockchain such as Cardano.
✓ This allows the blockchain to remain decentralized and thus verify transactions in a secure and fast way.
✓ And this way you get passive income from the blockchain network for freezing your PoS tokens.
The main disadvantage of traditional staking via the blockchain protocol is that profits are often super low. In addition, the process is only suitable for PoS cryptocurrencies.
That is why, when engaging in staking, it is much better to use DEX. This will not only give you access to much higher returns, but a wider pool of supported tokens and not necessarily PoS.
✓ When it comes to the basics, you must first decide which token you want to stake and for how long.
✓ For example, if you bet a CRO on Crypto.com, you will earn an APY of 6% to 12% - depending on whether you opt for a 1, 3, 6 or 12-month term.
During your chosen lock-up period, you will not have access to your tokens. This means that under no circumstances can you shorten the lock-up period - even if you need immediate access to funds.
On the contrary, you'll have to wait for the deadline to pass before you get your tokens back - in addition to the interest you've earned.
This is in stark contrast to yield farming, which usually comes in the form of flexible terms,
The main advantages of Yield Farming
The main advantages of yield farming are as follows:
Flexible terms and conditions
The debate over the combination of yield farming and staking often boils down to a question of flexibility. This is because in most cases yield farming pools do not require you to agree to a minimum lockout period.
This means that you can add or remove liquidity whenever you want. If you feel you are overexposed you can make immediate withdrawals .
On the other hand, if it turns out that a particular yield farming pool works well for you in terms of APYs, you may decide to deposit more tokens.
Depending on the trading pair you choose, you may have access to substantial profits that exceed anything staking platforms can pay.
This, of course, depends on how fluid and variable the pair is.
For example, if you're looking for liquidity for a new and relatively unknown cryptocurrency token, there's a good chance the pool will yield a triple-digit APY.
Even highly liquid pairs can produce double-digit returns, so cryptocurrency farming is so popular.
Main advantages of staking
The main advantages of staking are as follows:
Single token required
As mentioned above, when you engage in yield farming tool, you will need to provide liquidity for the trading pair. Therefore, you must have equal funds of both tokens.
In comparison, when you pack cryptocurrencies, you must have only one type of token.
In fact, except for Bitcoin and Ethereum, most cryptocurrency tokens can be bet on with double-digit returns.
Another benefit you may want to consider in this comparison of yield farming or cryptocurrency staking is that the latter comes with an established APY.
This means that you know exactly how much you will earn at the end of the staking period.
Note, however, that the monetary value of the investment will depend on the price action of the particular token being staked.
Yield Farming or Staking : Stakes.
When deciding whether yield farming or cryptocurrency staking is the best DeFi product for you, the main metric to consider is the amount of APY you will be able to generate. After all, the main purpose of borrowing your cryptocurrency tokens is to make money.
In short, there is no hard and fast rule for how much you can earn for both yield farming, as well as staking, because there are a lot of variables involved.
Type of token
First of all, the type of cryptocurrency token you want to farm or staked will have a big impact on the returns offered. For example, if you want to stake a large-cap token such as Ethereum, you should expect a lower APY.
This is because Ethereum is already an established cryptocurrency project, and therefore - it attracts more interest from wider markets. This would also be the case if you were to provide liquidity for a pair like ETH/USDT.
At the other end of the spectrum, staking an emerging cryptocurrency token like VVS or V3S would attract a much higher profit. Similarly, if you were to farm a less liquid pair like VVS/CRO, it would also generate a higher APY.
Deadline for blockade
It is clear that APYs will generally increase when you agree to lock your tokens for an extended period of time.
For example, if you decide to put your tokens on a flexible basis, then the APY offered will be much lower than agreeing to lock up the funds for 12 months.
As a result, you will very rarely have to agree to a lockout period when you decide to yield farming.
Fixed and variable rates of return
Another thing to note about income rates for both yield farming and staking is that the latter are usually fixed. This means that when you commit to a staking contract, you will know exactly what APY you will earn.
This will suit those of you who want to reduce volatility risk as much as possible. Yield farming, however, does not provide such a hedge. On the contrary, you don't know what rate of return you will come out with.
After all, interest rates fluctuate throughout the day depending on a number of factors, such as volatility, arbitrage opportunities and liquidity levels.
Yield Farming or Staking: the Risk.
Another factor to consider in the debate over the yield farming or cryptocurrency staking is risk. There are many risks associated with both investment products, which we will discuss below:
The first risk to consider is specifically related to staking. Simply put, if you decide to lock your tokens for a minimum number of days with the intention of making higher profits, you won't be able to touch the funds until the period ends.
At this time, this means that you may miss out on other, more profitable investment opportunities. As we mentioned earlier, once your tokens are locked - they are held by a smart contract that cannot be changed.
This means that no matter how much you need access to the tokens, you will have to wait for the smart contract deadline to release the funds when the appropriate date arrives.
Generally, you will not have this risk, when you engage in yield farming. This is because in most cases you will always have the option to withdraw your tokens from the yield farming liquidity pool as and when you want.
Impairment risk - i.e. Impairment loss risk
Risk specific to yield farming is the risk of loss of value. This can be somewhat complicated to understand at first glance.
Nevertheless, the main notion from the impairment is that you could have made more money simply by leaving your tokens in a private wallet - as opposed to depositing them into a liquidity pool.
✓ For example, let's say you provide liquidity for the ETH/USDT pair.
✓ You have decided to provide the equivalent of $500 in both ETH and USDT, so your total investment is $1,000.
✓ We will say that you generate an APY of 40% by farming ETH/USDT in three months.
✓ In a three-month perspective, this means that your tokens have increased by 10%.
✓ However, if you were able to earn 20% during the same period, leaving your ETH and USDT in a private portfolio, you suffered a loss in value.
In the end, the process was somewhat counterproductive, as you would have generated a great APY if you had avoided farming a particular pair.
Both staking or yield farming of cryptocurrencies carry an inherent level of volatility risk. In its most basic form, this refers to the risk that the value of the tokens you have deposited in a liquidity pool or staking.
This means that when you eventually withdraw your cryptocurrency assets, your investment may still be worth less than what you started with - even if you have more tokens.
✓ For example, suppose you deposit 1 ETH into a 12-month staking contract at an APY of 20%.
✓ At the time of deposit, ETH is listed at $2,000 per token.
✓ At the end of the 12-month staking period, you pay out your original 1 ETH, plus 0.20 ETH in interest (20% of 1 ETH).
✓ This means that you now own 1.2 ETH. However, ETH is currently trading at $1,000 per token - so your funds are worth $1,200 at current market prices.
✓ Because you originally invested the equivalent of $2,000 - you suffered a loss of $800 - even though you now have 20% more in ETH tokens.
Perhaps the risk of volatility is more pressing with staking, because with yield farming you can usually withdraw your tokens at any time. With staking, you won't be able to withdraw your tokens until the relevant lock-up period is over.
You should also consider the risk of the platform you are using for staking or yield farming. After all, you will be going through a third-party platform. The only exception to this rule is if you decide to staked your tokens directly on the blockchain network in question.
However, the specific risks associated with the platform will depend on whether it is centralized or decentralized.
If it's the former, then you have to trust that the centralized site will keep your tokens safe, and then pay you what was contractually promised.
In comparison, when staking or yield farming through a decentralized platform, you deposit funds directly into a smart contract. This means that the platform will not have direct access to your tokens.
Risks associated with smart contracts
Leading on from the above section, smart contracts on decentralized platforms are not without risk. This is because if a smart contract is not built correctly, it can be vulnerable to hackers.
Therefore, you still need to do your research when choosing DeFi platforms - whether you prefer yield farming or cryptocurrency staking.
Who is Yield Farming best for?
Yield Farming is probably the best option for experienced cryptocurrency investors who are content to take on additional risk with the goal of achieving much higher returns.
As mentioned earlier, when you add tokens to a liquidity pool, you will usually be able to generate a higher APY compared to staking. But, you are also taking on the additional risk of losing value.
On the other hand, yield farming is also suitable for those of you who want more flexibility when it comes to accessing your tokens.
This is because you usually have the option of withdrawing your cryptocurrency assets from the yield farming pool at any time - without restrictions.
For whom is staking best?
Staking will be the best option for those of you who want to know exactly how much you will earn in exchange for locking up your tokens.
This is because in most cases the rates are fixed. So if you deposit 1,000 CRO tokens into a staking pool for 12 months at APY 12%, you know you'll get 1120 CRO back at the end of the period.
Therefore, staking may not be suitable for you if there is a chance that you need immediate access to your funds. This is because once the tokens are locked into a contract, you won't have access to them until the term ends.
If this is the case, you may want to look for a flexible staking arrangement. While this will bring a lower APY, you may at least be able to withdraw tokens at any time.
The best platform for staking and Yield Farming
Now that you know the difference between staking and yield farming, you've probably decided which DeFi product is best for you. If so, the next step is to find the right platform that will facilitate your DeFi investments.
We have found that the best platform for this purpose is Crypto.comp - which offers both staking and yield farming services in a decentralized as well as centralized secure user-friendly manner.
The views and opinions expressed here are solely those of the author and should not be taken as financial advice either. Every investment and transactional activity involves risk, so you are advised to do your own research when making any trading, investment or financial decisions.