Understanding yield farming in cryptocurrency
What is yield farming?
Yield farming is a Decentralized Finance (DeFi) strategy where users provide liquidity with their crypto assets to earn rewards which can turn into passive income. By interacting with liquidity pools on DEXs and lending protocols, investors receive incentives like interest, fees, or tokens. This process enhances liquidity and drives engagement in the DeFi ecosystem.
Simply put, it’s about making your cryptocurrency generate profits by utilizing decentralized platforms.
Understanding staking in cryptocurrency
What is staking?
Staking is a process that allows you to earn rewards and potential passive income by contributing to the security and efficiency of a blockchain network. By locking up your cryptocurrency, you help validate transactions and maintain the network’s stability. In return, you receive additional tokens as a reward. Unlike lending, your assets remain within the network and aren’t loaned to others. Yield farming staking is considered a safe and accessible way to passively grow your crypto holdings while supporting the blockchain ecosystem.
Yield farming vs staking: key differences and similarities
Differences between yield farming and staking
Levels of complexity
Yield farming staking is generally simpler than yield farming liquidity, as it only requires locking assets to support a blockchain network. On centralized exchanges (CEXs), staking yield farming can be done with a single click, making it even more accessible. However, this comes with the trade-off of using a custodial service, meaning you don’t have full control over your assets. In contrast, yield farming liquidity is more complex and requires a solid understanding of DeFi protocols. Investors need to carefully choose platforms, manage liquidity pools, and optimize their strategies, making it a preferred option for experienced Decentralized Finance (DeFi) participants, often referred to as "degens.”
Deposit periods
Staking yield farming typically involves locking up assets with a cooldown phase in which funds cannot be withdrawn. This can limit liquidity and flexibility. On the other hand, yield farming usually offers more freedom, allowing yield farmers to deposit and withdraw assets from liquidity pools at any time (it depends on which protocol you’re using). This flexibility makes yield farming more appealing for those who prefer to move their funds quickly based on market conditions.
Transaction fees
Both yield farming staking and yield farming liquidity involve transaction fees, which vary depending on the blockchain and platform used. Yield farming staking requires transaction fees when initially locking assets and when withdrawing them after the staking period ends. In yield farming liquidity, users must pay fees when depositing assets into liquidity pools, as well as when claiming rewards or moving funds between protocols. These fees can add up, especially on networks with high gas costs like Ethereum.
Token requirements
Yield farming staking usually requires investors to hold and lock a specific cryptocurrency that is native to the blockchain they are supporting, such as ETH for Ethereum staking or ADA for Cardano staking. Yield farming liquidity, however, often involves providing liquidity with a pair of tokens in a decentralized exchange (DEX) pool. This means yield farmers need to hold and deposit two different assets, which can expose them to price fluctuations and impermanent loss.
Earning revenue potential
Yield farming staking generally offers lower but more stable returns, as rewards are generated through network participation. Yield farming liquidity, on the other hand, can be much more lucrative, especially when new protocols launch and offer extremely high annual percentage rates (APR) to attract liquidity. However, these high returns come with increased risks, as the sustainability of such rewards is not always guaranteed.
Risk factors
Yield farming staking and yield farming liquidity both involve risks, but of different types. In staking yield farming, the main risk is slashing, where validators can lose a portion of their staked assets if they act maliciously or fail to maintain uptime. Yield farming liquidity, meanwhile, carries the risk of impermanent loss, which occurs when the value of deposited assets in the liquidity pool changes significantly, leading to potential losses compared to simply holding the tokens. Additionally, yield farming liquidity exposes users to smart contract vulnerabilities and rug pulls, making careful research essential.
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Similarities between yield farming and staking
Despite their differences, yield farming from liquidity pool and yield farming from staking share several common traits, making them both popular choices for crypto investors looking to earn passive income.
Earning passive income
First, both methods allow investors to earn passive income by putting their crypto assets to work. Instead of simply holding tokens in a wallet, investors can stake them to secure a blockchain network or provide assets in liquidity pools through DeFi protocols to earn rewards and generate potential passive income. In both cases, users receive and benefit from incentives in the form of additional tokens, whether through staking rewards or liquidity provider (LP) fees.
Volatility risk of tokens
Both yield farming from liquidity pool and yield farming from staking involve exposure to token volatility. Since rewards are usually paid in cryptocurrency, the value of earnings fluctuates with the market. A sudden drop in token price can significantly impact overall profits, meaning participants in both strategies must be aware of potential losses due to market downturns.
Trust in the blockchain or protocol
Finally, both strategies require trust in the blockchain or protocol. Whether staking yield farming on a blockchain or providing liquidity in Decentralized Finance (DeFi), users must rely on the security and stability of the system they engage with. Risks such as smart contract vulnerabilities, network issues, or governance changes can affect both yield farmers and stakers, making due diligence crucial before committing funds.
Comparison between yield farming and staking
| Criteria | Staking | Yield Farming |
| Complexity | Simple, just lock assets. Easier on CEXs but less control. | Varies by protocol—some are simple deposits, others require advanced DeFi knowledge. |
| Deposit Period | No locking, but withdrawal requires a waiting period of a few days. | Depends on the protocol—some allow instant withdrawals, while others require locking for higher rewards. |
| Fees | Fees for staking/unstaking. | Fees for deposits, withdrawals, and claiming rewards. |
| Token Requirements | Requires a single blockchain-native token. | Can involve one or two tokens, depending on the platform or method (lending or liquidity pools). |
| Earnings | Lower but stable rewards. | Higher potential returns but riskier. |
| Risk | Slashing risk (loss if validator fails). | Impermanent loss, smart contract risks. |
| Passive Income | Generates steady rewards. | Also passive but needs more management. |
| Volatility | Exposed to token price changes. | Exposed to token price changes. |
Is yield farming better than staking?
Whether yield farming liquidity is better than staking yield farming depends on your risk tolerance and investment strategy. Yield farming staking offers stable, lower-risk rewards by securing a blockchain, making it ideal for long-term investors. Yield farming, on the other hand, can generate higher returns but comes with increased risks, including impermanent loss of the liquidity pool and smart contract vulnerabilities. If you prefer passive income with minimal management, staking yield farming is the better choice. However, if you're willing to actively manage your funds and take on more risk for higher potential rewards, yield farming from a liquidity pool might be the right option.
Key considerations before investing in yield farming or staking
Risk tolerance
Before engaging in yield farming liquidity or staking yield farming, it’s crucial to assess your risk tolerance. Yield farming, with its high returns, comes with higher volatility and risks such as impermanent loss, while yield farming staking offers more stability but still involves slashing risks if a validator fails. Understanding your comfort level with these risks is essential for making an informed decision.
Investment objectives
Clarify your investment goals—are you looking for steady income or high returns? Staking yield farming is ideal for those seeking stable, long-term rewards with lower risk, whereas yield farming may appeal to investors who are willing to take on more risk for potentially larger rewards. Matching your strategy with your objectives helps ensure the right approach.
Time investment
Consider how much time you're willing to dedicate to managing your investments. Staking yield farming usually requires minimal effort once assets are locked, but yield farming often demands active management to optimize returns. Depending on your availability, you may prefer the simplicity of staking or the higher involvement of yield farming.
Skills and understanding
Yield farming requires a deeper understanding of DeFi protocols and the risks involved, including smart contract vulnerabilities and liquidity pool dynamics. In contrast, staking yield farming is relatively easier and less technically demanding. Evaluate whether you have the necessary skills and knowledge or if you're willing to learn before jumping into either option.
Portfolio diversification
Diversifying your investments can help spread risk. Both yield farming from liquidity providing and yield farming from staking can be part of a diversified crypto portfolio, but they should complement other assets like traditional investments or different cryptocurrencies. This balance minimizes exposure to the potential volatility of any single strategy.
Security
Security is paramount when investing in crypto, as both yield farming and staking expose assets to smart contract risks. Choosing reputable platforms with robust security measures and audits can help mitigate these risks. Always ensure the safety of your funds by verifying the protocols’ security track record.
Asset liquidity
Consider the liquidity of your cryptocurrency before staking or yield farming. While staking yield farming often involves locking up funds for a period, yield farming liquidity offers more flexibility but can still have constraints depending on the platform. Knowing when and how easily you can access your funds is key to managing liquidity risks.
Costs and fees
Both yield farming liquidity and staking yield farming involve transaction fees, which vary depending on the blockchain and platform used. These fees can eat into your profits, especially on networks with high gas fees. Always calculate the potential costs and make sure they align with your expected returns to ensure profitability.
Exit strategy plan
Having a clear exit strategy is essential in both staking and yield farming. This includes knowing when to withdraw funds, how to manage changes in market conditions, and whether you will reinvest rewards or cash out. Planning ahead ensures you can act quickly and avoid emotional decisions during market fluctuations.
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How to invest in yield farming or staking
Example of the most popular yield farming platforms
Compound
Compound is one of the leading decentralized lending and borrowing platforms. Users and yield farmers can earn interest by supplying liquidity in the form of cryptocurrency to various liquidity pools. In return, they receive COMP tokens, which act as a governance token and provide additional rewards.
Aave
Aave is another popular DeFi lending platform that allows users and yield farmers to earn rewards by providing liquidity to lending pools. Aave offers features like flash loans and variable interest rates, and its native token, AAVE, gives users governance rights and staking opportunities.
Curve Finance
Curve Finance focuses on stablecoin liquidity pools, offering low slippage for users providing liquidity to pools. It’s designed for efficient stablecoin swapping with minimal price impact, attracting liquidity providers who seek stable returns. Curve’s native token, CRV, rewards liquidity providers.
Uniswap
Uniswap is one of the largest decentralized exchanges (DEXs), where users and yield farmers can earn rewards by providing liquidity in pools. Unlike centralized exchanges, Uniswap operates without a middleman, and liquidity providers are rewarded with fees from trades made on the platform. Uniswap uses its governance token, UNI, for governance decisions.
Merkl
Merkl is the leading incentive distribution platform, connecting DeFi protocols in need of liquidity with liquidity providers, whales, or yield farmers. Users can earn incentives and passive income by completing actions such as depositing liquidity into pools, holding specific tokens, or lending tokens. These incentives can be claimed on the Merkl platform, making it a key player in the Decentralized Finance (DeFi) space.
Example of the most popular staking tokens
Ethereum (ETH)
Ethereum, the second-largest cryptocurrency by market cap, allows investors to stake ETH to help secure the network through the Ethereum 2.0 upgrade. Stakers earn rewards in ETH, which increases as the network grows and transaction throughput improves.
Solana (SOL)
Solana is a high-performance blockchain that supports staking through its proof-of-stake (PoS) model. Investors can stake SOL to support the network’s security and consensus. In return, they receive staking rewards paid in SOL, making it a popular choice for long-term investors.
BNB (BNB)
Binance Coin (BNB) is the native token of the Binance ecosystem, and it can be staked to help secure the Binance Smart Chain (BSC). Stakers earn BNB as rewards, which can be used for platform fees or reinvested for additional returns.
Cardano (ADA)
Cardano operates on a PoS model, where investors can stake ADA to participate in block production and earn rewards. Cardano’s staking is considered energy-efficient and offers low-risk rewards, making it a popular choice for passive income seekers.
Avalanche (AVAX)
Avalanche is a fast, scalable blockchain that also uses staking to secure its network. By staking AVAX tokens, investors help secure the Avalanche network and earn AVAX as rewards. Staking AVAX is an attractive option for those looking for high-speed, low-cost blockchain solutions.
Conclusion
Both yield farming liquidity and yield farming staking offer ways to earn passive income. Staking is simpler and more stable, while yield farming offers higher returns but with greater risk. Investors should assess their risk tolerance, goals, and security before choosing. Understanding liquidity, costs, and time commitment is key to long-term success in Decentralized Finance (DeFi).
FAQs about yield farming vs staking
Is yield farming the same as staking?
No, staking secures a blockchain by locking assets, while yield farming liquidity provides liquidity to DeFi protocols for higher but riskier rewards.
Is yield farming better than staking?
It depends on your goals—staking is safer and more stable, while yield farming offers higher returns but requires active management and carries more risks.
Is yield farming still profitable?
Yes, but profitability depends on market conditions, protocol incentives, and fees. High returns often come with increased risks.
