Without a doubt, the DeFi space is growing. With the newly emerging solutions, businesses and people are understanding the potential of DeFi. Decentralized finance has boosted the prospects for improved financial inclusion around the world and the tools for using and managing digital assets.
Staking and yield farming are popular solutions in DeFi trading to obtain returns on crypto assets. Each has a different approach to how participants pledge their crypto assets in decentralized applications or protocols. Furthermore, the underlying technologies reveal other distinctions between the options.
There was staking before yield farming, and there was mining before staking. As time passes, blockchain developers discover new ways to provide passive income opportunities that allow users to use their existing resources to acquire more crypto assets.
Yield farming was a great hit in 2020, and it thrived alongside DeFi and all of its glitzy new features. Crypto investors have inevitably forgotten staking because supplying liquidity to DEXs is several times more profitable than staking.
However, do the risks of yield farming still mean that staking is the better solution for investors?
This article focuses on staking and yield farming to help understand how you can achieve a productive return from crypto assets with either of the strategies.
What is Yield Farming?
Yield farming, also known as liquidity mining, makes money with cryptocurrencies by temporarily lending crypto assets to DeFi platforms in a permissionless setting. The core product of the DeFi market is decentralized exchanges (DEX), and to enable trades, they rely on investors who are ready to help them. A yield farmer earns a share of the platform’s fees when he supplies liquidity to a DEX like Uniswap, which are paid for by token swappers who use the liquidity.
Farmers can contribute their assets for as long as they choose. The user will receive money daily for the duration, as short as a few days or as long as a few months. As they lend more, the greater the rewards.
Yield farming pools are highly competitive due to their high yield rates (APY). Rates often fluctuate, forcing liquidity farmers to move platforms regularly. On the other hand, the farmer must pay gas fees each time he leaves or enters a liquidity pool. Hunting for high-APY LPs on the Ethereum network is nearly impossible during periods of significant network congestion.
Yearn Finance, for example, combats this problem with a product called ‘Vaults,’ which implements automatic yield farming tactics. DeFi’s the farmer’s assets will be deposited into a vault on Yearn Finance, which will constantly rebalance its assets among all of DeFi’s LPs in order to partake in the best yield farming possibilities. The vault also reinvests money to expand its size, resulting in more significant returns for future yield farming opportunities.
The true benefit of the arrangement is that investors who lock up their coins on the yield-farming system can earn interest and often more bitcoin currencies. If the value of those additional coins rises, so do the investor’s profits. According to Jay Kurahashi-Sofue (VP of Marketing at Ava Labs), yield farming is comparable to the early days of ride-sharing. “To bootstrap growth, Uber, Lyft, and other ride-sharing apps gave incentives for early users who recommended additional users onto the platform,” he explains.
Yield farming is an excellent technique to get your bit for free from the pool and is regarded as safer than crypto staking. That isn’t to say that there aren’t any risks associated with yield farming. There is no reward without risk, as the saying goes.
Yield farming is a method of putting your virtual assets to work on several networks. Let’s imagine you’re using Binance smart chain, which is one of the most popular. It makes use of smart contracts to lend your money to others. Consider these contracts to be nothing more than lines of computer code that run on the blockchain structure and handle money (cryptocurrencies) on the owner’s behalf.
When you pool your cryptocurrency liquidity into a farm, you allow the currency’s borrowing and lending mechanisms, putting your money at the mercy of the developer. The developer creates a bridge between controlled and decentralized currencies to increase the currency’s scalability in the long run.
Because the developer has authority over your cash, there’s a chance they’ll wind up with all of your money. When the developers are unknown, there is a very high chance of this happening.
The issue about computer code is that, whether for a website design or something as complex as a blockchain cryptocurrency architecture, the developer is bound to make mistakes. Even a single “;” might cause various problems in the final build.
These problems aren’t always as serious. A click might not work, a colour might change on its own, the layout might not be symmetrical, and so on. However, some of these defects have been proven to be quite dangerous, allowing cybercriminals to exploit and profit from them.
Ethereum fee risks aren’t as severe for major investors in a farm because the quantity invested, and the expected returns make these fees a mere rounding error. However, these costs can eat up a significant portion of their gains for smaller investors. For example, the earnings might not be close to what they pay in gas fees, causing them to lose money.
What is Staking?
Staking is a technique evolved from the Proof of Stake consensus model, an alternative to the energy-intensive Proof-of-Work approach of cryptocurrency mining.
Stakers lock up their assets to function as nodes and confirm blocks, rather than paying electricity and hardware power to confirm transactions and solve complex mathematical problems.
For example, to apply for a node job on the new Ethereum 2.0 network, users must first lock up 32 Ether. Once locked up, the assets will act as a ‘stake,’ forcing the user to confirm transactions in good faith.
Users who build up a node independently and join any PoS network to act as a node validator are known as stakers. This isn’t always the case, though.
Users can stake their assets without dealing with the intricacies of setting up a node on centralized and decentralized exchanges (or any platform where assets can be stored for any reason). The staker’s only responsibility will be to offer the assets, while the exchange will handle the verifying part of the procedure on its own.
This allows the user to stake several assets from a single location. Furthermore, he will not be subjected to the effects of slashing, a system that reduces a user’s assets when he engages in malicious behaviour.
To summarise, the primary purpose of staking is to secure a blockchain network by increasing its security rather than providing liquidity to it. The more people who invest, the more decentralized the blockchain, making it more difficult to hack.
The only disadvantage is that staking is not as cost-effective as yield farming. Annual percentage yields (APYs) range from 5% to 15% and are paid out yearly. On the other hand, in some situations, yield rates in LPs might exceed 100 percent.
Yield farming vs staking
We have discussed yield farming and staking, but which is best for the investor?
Yield farming is the most profitable passive investment option, but it is also the most dangerous. Ethereum’s gas fees can wipe out the APY rates you’ve just earned, and if markets turn wildly bearish or bullish, the rate of profitability will plummet owing to temporary loss.
Yield farming on newer projects may result in a complete loss in terms of security, as developers frequently design so-called rug pull initiatives. The project’s developer will shut down the project and disappear with the funds after listing a new coin and allowing customers to deposit funds into liquidity pools.
Although the creator is acting in good faith and working on a serious project, he may unwittingly introduce a flaw in the smart contract’s code that a hacker can exploit.
That isn’t to suggest that the benefits don’t outweigh the risks. Yield farming is one of the most risk-free ways to earn cryptocurrency. All you have to do now is keep the risks mentioned above in mind and design a strategy to address them.
There are two significant drawbacks to staking: low APY rates and timelocks.
On a PoS-based blockchain network, validating transactions does not generate the same benefits as yield farming. As previously said, yields vary from 5% to 15%, and they do not go any higher than that.
Second, some projects impose timelocks. A staker may be obliged to keep his assets locked for the entire year. He is unable to move or sell his assets during this time. If a bull market abruptly changes into a bear market, the investor will lose more money than he received by staking.
Yield farming and staking both have advantages and disadvantages. The determining factor should be the investor’s appetite for risk. For those confident that they can gain more money in a short timeframe, yield farming is the right option. However, if that’s not the case, you may be better joining Ethereum 2.0 and participating in staking.
Calculating the best ROI between yield farming and staking may lead to a preference for yield farming, but the argument should go further.
For beginner crypto investors, yield farming can be considerably more confusing, and it may demand more work and research regularly. Staking crypto provides lower benefits, but it does not necessitate the investor’s constant attention, and funds can be held for extended periods.
It boils down to the type of investor you want to be and your experience level in the DeFi industry.
Disclaimer: The author of this text, Jean Chalopin, is a global business leader with a background encompassing banking, biotech, and entertainment. Mr. Chalopin is Chairman of Deltec International Group, www.deltecbank.com.
The co-author of this text, Robin Trehan, has a Bachelor’s degree in Economics, a Master’s in International Business and Finance, and an MBA in Electronic Business. Mr. Trehan is a Senior VP at Deltec International Group, www.deltecbank.com.
The views, thoughts, and opinions expressed in this text are solely the views of the authors, and do not necessarily reflect those of Deltec International Group, its subsidiaries, and/or its employees.
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