What Is The Difference Between Yield Farming vs Staking?

The crypto space has a lot of terms and complicated jargon, and it seems like every couple of months, there’s 100 new terms you need to learn if you want to keep up.

Yield farming is not just another term though. It’s a pillar concept of DeFi. Just like staking.

Learning the differences between yield farming vs staking will help you make smarter decisions regarding your crypto assets and how to deploy them for the best returns.

What Is Yield Farming?

The crypto industry constantly pushes for new and elaborate ways for turning a profit.

Just think about NFT Staking. Who could ever imagine that?

Yield farming came into life during the bull run of 2020, a period of several months that was later dubbed “DeFi Summer”.

During that time, yield farming was popularized by a wave of new crypto projects, with “Compound” being the pioneers who are credited with kicking things off.

Many projects have followed, and a whole new industry of yield farmers was born.

Yield farming can seem a bit intimidating even for those who have experience in the crypto space, but it really shouldn’t be.

Yield farming is a nickname given to the process of locking your assets inside a “Smart Contract” of a DeFi platform. Doing that allows others to “Borrow” these assets. You are incentivized to lend out your assets in this way in the form of interest and rewards: The more coins you lock, and the longer you keep them locked, the more profits you receive.

It’s that simple.

On a technical level, the assets are deposited into the platform’s smart contract, which in turn allows borrowers to use these assets for various DeFi activities.

Borrowers pay an interest, while lenders, receive interest.

Unlike platforms like Coinbase, Binance, Kraken and others that offer lending solutions, and pocket the interest, with DeFi – the interest ins distributed to the lenders directly.

This interest is referred to as “yield”, and those who seek that yield are known as “farmers”.

Hence – “Yield Farming”.

Yield Farming Example

For example, depositing your crypto on platforms such as Compound, Balancer, Aave or Curve in order to generate profits is a form of yield farming.

Some people refer to yield farming as “liquidity mining”, but they are essentially the same thing.

Yield farmers typically enjoy returns in the form of more of the token they deposited, so for example ETH would produce more ETH. In addition, other incentives such as the farm’s native tokens, are given to yield farmers to persuade them to lend their assets (in other words – provide liquidity).

Here’s an example of how your yield farming journey can look like:

• Choose which platform you want to farm on
• Connect your MetaMask account
• Choose which asset you want to lend out
• Send your transaction using MetaMask
• Receive confirmation
• To get even more profits, you can now borrow against your assets and earn even more APY on other DeFi platforms. That’s the magic of yield farming.

What Is Crypto Staking?

Proof-Of-Work, also known as “Crypto Staking”, is a mechanism that was developed in 2012 as the eco-friendly solution to Proof-Of-Work’s rising energy demands, known as “Crypto Mining”.

Crypto Staking is the act of locking your assets inside a “Smart Contract” on the blockchain. Doing that helps secure and operate the blockchain of the asset you choose to stake. You are incentivized in the form of staking rewards: The more coins you lock, and the longer you keep them locked, the more profits you receive.

Instead of investing massive amounts into the energy required to solve PoW’s complex equations in order to achieve consensus, with staking, you simply lock up your crypto assets into a smart contract on the blockchain, and enjoy staking rewards. It’s faster, more efficient, and most importantly – consumes 99% less energy than mining.

Crypto Staking Example

Let’s take on of the most popular crypto staking assets in the world: Ethereum. It’s native token, ETH, is what you will be staking, and you will also be receiving your interest (staking rewards) in ETH.

In order to stake ETH, you must choose whether you want to

• Stake independently from home
• Stake independently on the cloud
• Stake on an exchange
• Stake using a third-party service
• Stake using a shared staking pool

Once you’ve decided on your preferred solution, you would proceed to deposit your tokens.

If you choose to stake independently, you would then need to run the validation software on your device, and make sure it stays online at all times. For Ethereum, a minimum of 32 ETH tokens are required to stake independantly.

If you use one of the other options, they would be running the software on your behalf. Some staking solutions like shared staking pools allow you to stake less than 32 ETH, and you would be pooled together with other stakers.

The main idea remains the same – if you behave in a malicious way, or the service you use does – your stake gets slashed and you lose funds.

What’s The Difference Between Yield Farming vs Staking?

The differences between yield farming vs staking are in the potential profits and the risks that an investor undertakes.

In yield farming, the potential profits are usually much higher than with crypto staking, but also come with greater risks.

That’s because in yield farming, the goal is oftentimes more about “maximizing profits” and seeking the best returns, while with staking, the goal is more “long term holding”, while making some profits and helping secure the blockchain in the process.

It’s not rare to see yield farming returns of 20%, 50% or much more than that, depending on how ‘New’ and unproven the token or the platform you’re using is.

These high returns are the incentive that is used to bring in liquidity providers.

On the other hand, you would be extremely hard-pressed to find Proof-Of-Stake chains that offer more than 15% in returns to crypto stakers. For context, Ethereum’s Beacon Chain is currently giving returns of 4.5%.

The logical question in the yield farming vs staking debate is then…

“Why would I stake then? Yield farming seems much better for making profits!”

And you would be correct, in almost all but the rarest of cases, you would make more profit with yield farming.

But you would also make more profits by betting on growth tech stocks compared to investing in the blue chip Google and Amazon.

It depends on your taste for risk.

Risks Of Yield Farming

There are quite a few risks in yield farming. In fact, outside or margin trading, it’s one of the riskier activities you can do in crypto. Here are some of the more significant risk factors that you should watch out for.

Risk Of Impermanent Loss

This one is probably something that everyone learn about pretty quickly when they start yield farming. It’s almost as if no one can imagine the idea of impermanent loss until they experience it, but once they are looking at one, it’s clear as day.

The idea here is simple – Because liquidity pools operate on paris (example: DAI/ETH) you might run into a scenario where the value of your assets in absolute terms declined while you were lending them out, and it might have been smarter to just hold on to your original token instead of lending it out. For an elaborate explanation on this click here

Smart Contract Risk

This is always a risk with Crypto, but it’s even more significant when it comes to yield farming. Because we’re talking about new technologies, the audit game is still not as strong in this space. One of the risks you take on as a yield farmer, is that the platform you’re using would get hacked, and its liquidity pools drained.

This is not as big of a risk with the older, more established platforms, but could still happen and should be taken into account.

Scams

Creating a liquidity pool or a DEX is now easier than ever, and rug pulls occur all the time. It has been one of the most popular scams in the crypto space throughout the past 2 years. Yield farmers see a new pool offering insane 500% yield farming returns, deposit some coins, see some sweet profits, and then a week later – poof. It’s all gone, the owners cashed out and you’re left holding a bag of worthless tokens.

Don’t get tempted by brand new project promising unrealistic returns. Some of them might pan out and be amazing, but more often than not, if it’s too good to be true – there’s a reason for that.

Risks Of Staking

When it comes to the risks of yield farming vs staking, the latter has a lot less risks. At the same time, they should also be considered when fairly comparing the two options. Here are the top ones.

Slashing Risk

Depending on how you are staking, you are exposed to a risk of getting your stake slashed. If you’re an independant staker, you could mess something up during your validator setup, or if you’re using an exchange, they could make a large-scale mistake that affects an entire staking pool.

While somewhat rare when using third-party services, this could happen, and have happened. Even third party custodial staking services have messed up and got slashed in the past.

Lockup Period

When you stake crypto, in almost all cases, there’s an unlocking or unstaking period. In some cases it could be hours, days, or sometimes – an unknown period of time, as with the case of Ethereum Staking, where ETH can only be unstaked once The Merge happens.

This is a risk because based on price movement, or price crashes, you might be unable to sell your coins in time.

Smart Contract Risk

Same as with yield farming, there’s a risk that the staking smart contract, or the smart contract used by the service you use for staking – gets hacked.

For example, the risk of the Ethereum staking smart contract getting exploited and drained is extremely minimal, but there’s a much higher chance that a shared staking pool’s protocol could be compromised.

Yield Farming vs Staking – Which One Is Better?

This depends on your taste for taking risks, and your investment horizon.

If you’re currently looking to maximize profits using a certain part of your portfolio, and you have time to actively “manage” things, then you should definitely consider yield farming.

The need to “manage” will come from wanting to move between assets, or find the best yields as the APY on your pair might decline.

If on the other hand, you are thinking of a more passive approach that carries less risk, than helping secure the blockchain of your favorite crypto coin, while enjoying staking rewards, then staking is definitely the direction you want to be looking at.

But there’s also a third option.

You can do both. In the debate between yield farming vs. staking, you don’t necessarily have to decide.

You can stake part of your crypto, and you can allocate a part for yield farming.

That way, you get partial exposure to a safer form of investment – staking, while actively trying to maximize your returns with yield farming.

Remember to keep the risk factors in mind, and try to avoid them by using safe and proven platforms.