Yield Farming vs. Staking: What’s the Difference?
Yield farming and staking are the two most lucrative methods to generate income on crypto holdings. Find out what sets them apart.
Filip Dimkovskion April 8, 2022.
Defining the Crypto Generating Methods
What Is Yield Farming?
Here, you're incentivized to add tokens to liquidity pools (LPs) governed by smart contracts. The DeFi protocols put these funds to better use, like lending and trading, and you get a share of the profit generated in exchange (sometimes LP tokens too). Usually, these returns are measured in Annual Percentage Yield (APY), which is the return you'll receive when taking compound interest into account as well. You can yield farm LP tokens to generate further returns. Arbitrage opportunities in DeFi markets are sizable too.
Popular yield farming platforms include Compound Finance, Uniswap, Synthetix, Curve, and Aave. The returns depend on the yield farming strategy applied across different pools. Namely, yield farming returns are also calculated in APY, and the returns are denominated in the coins you'll be adding to the pool.
What Is Staking?
Staking allows you to generate income on your crypto holdings via a blockchain rather than a DeFi protocol. As proof of work (PoW) makes way for proof of stake (PoS) to reduce the environmental impact of running a blockchain, staking is gaining momentum.
PoW requires all participants to validate a block, while PoS selects validators at random to generate new blocks. You need to stake your coins to be a validator. The higher your share of coins, the better your chance of getting selected and the higher the staking rewards. Security breaches on the network are disincentivized by severing access to the staked assets.
Staking is also calculated in APY, and you'll earn the returns in the native token of the network. For example, if you're staking DOT on the Polkadot Network, you'll earn an approximate 10% APY in DOT.
Differences Between Yield Farming and Staking
The differences can be summarized as follows:
- In yield farming, you lock your funds in a DeFi protocol. In staking, you lock your funds in a blockchain.
- Yield farming facilitates liquidity, lending, and borrowing. Staking keeps a network up and running.
- Yield farming is prone to impermanent loss, smart contract vulnerabilities, and liquidity risks. Staking risks include long waiting periods for rewards and volatility risks.
- Yield farming opportunities are available on both native cryptocurrencies and stablecoins. Blockchain staking is limited to crypto coins.
Of course, both methods have their own advantages and disadvantages, which we'll briefly cover below.
DeFi Protocol and Blockchain
When it comes to DeFi protocols, there are a lot of options you can go for regarding yield farming and staking. Namely, you can earn passive income on native cryptos like BTC and ETH, or stablecoins like USDT and USDC. This requires using "blockchain locks" which lock up your assets for a specific amount of time. After the smart contracts in blockchain end, you can "unlock" your tokens and access them. Consider that you might have transaction fees for yield farming that vary depending on the blockchain you're using.
Yield Farming Returns Are Higher
In most cases, yield farming gives higher returns than staking, primarily because it's more complicated and riskier. Staking is real passive income, so once you stake your coins on a protocol, you won't have to worry about them until they're unlocked—which is why the APY is usually lower. However, yield farming often requires you to move the assets from one pool to another and bear the potential security risks of the protocols.
Level of Risk
Both yield farming and staking are considered relatively safe as long as you do them on reliable protocols. Still, both of them have inherent security risks. Yield farming can cause impermanent loss (i.e. the price of a token falling after you deposit the tokens in a pool) and are prone to smart contract vulnerabilities. If you've placed your tokens in a protocol that later gets hacked, you could lose some or all of your tokens—which is one of the biggest risks of yield farming.
In contrast, staking is slightly less risky, but the returns are smaller. You'll also have to wait for much longer (usually a couple of months) to redeem your rewards.
Which Is Better for Long and Short-Term Crypto Investments?
Both yield farming and staking are great ways to earn passive income. However, we wouldn't recommend yield farming for a long-term investment, because it's riskier than staking. Even though the APY for yield farming is better, the protocols can change how they function and what they do, thereby affecting your return.
However, staking is a solid long-term investment option, since it doesn't even require you to do anything. Once you stake your tokens on a protocol, you don't have to do anything until the lock-up period is over.
Therefore, we recommend yield farming for short-term returns and staking for long-term returns if you're goal is to grow wealth passively.
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