As the crypto market remains highly volatile, investors are looking towards passive income strategies instead of active trading to generate income. Staking coins and yield farming are some of the best ways to compound your positions in the cryptocurrency industry. The two strategies can dramatically affecting the size of your assets over time. They offer high rates compared to other markets such as Forex and Stock markets. New protocols that offer better staking rewards, as well as lucrative yield farming, are coming up. However, what is staking coins? And how does it compare with yield farming?
What is Yield Farming?
Yield farming is a method of generating funds from your cryptocurrency holdings. It involves lending crypto assets to Decentralized Finance for interest. The concept draws an analogy from farming since it involves “growing your own cryptocurrency.”
The users’ funds are locked in the liquidity pool to provide liquidity to a DeFi protocol and help facilitate functions such as lending, borrowing, and trading. The platform then rewards the investors using the fees that other users pay. DeFi runs by smart contracts and distributes the rewards proportional to the investors’ contributions to the liquidity pool.
Liquidity pools are essential for an automated market maker (AMM), which offers permissionless and automated trading to users. The pool enables AMM to run without the need for centralized authority, as seen in other systems of sellers and buyers.
Liquidity pool systems issue liquidity provider tokens (LP tokens) to liquidity providers to track their contributions pools for reward.
For example, if a DeFi user wants to exchange Binance (BNB) for Hi dollar tokens (HI), they will pay a transaction fee. This fee is paid to the liquidity providers according to the amount of LP tokens they hold. The more LP tokens an investor holds, the more the reward they get.
What are the Benefits of Yield Farming?
Yield farming is a way of making your idle digital assets work for you to generate passive income. As a yield farmer, you can lend tokens such as BNB through decentralized applications (DApps), such as Compound (COMP). The DApp then lends digital assets to borrowers. The interest earned from the lenders accrue daily and are paid in a specific coin that can also appreciate in value. The interests of yield farming are far much higher than regular banks. Yield farming applications are also decentralized, thus making the whole process both cheap and easy to start with and cheap. You only need crypto tokens to lend out and a digital wallet.
What is Coin Staking?
Coin staking is a less resource-intensive method of managing the blockchain network, which involves committing your crypto assets to the network. The method is based on the proof of stake (PoS) mechanism, which is an alternative consensus mechanism to Proof-of-work (PoW).
Unlike miners, the validators in the PoS blockchains stake their digital assets to get the opportunity to process the transactions that form the next block. These validators either are chosen randomly or are designated. The rewards come from the transaction fees other users of the blockchain pay.
A validator needs a node to take part in staking. In some cases, a staking protocol may require you to set up the node. However, most exchanges handle the node setup and validation process, requiring their investors only to provide their crypto assets.
PoS requires the initial setup to distribute digital assets fairly among the validators for the protocol to function correctly. Once the staking has begun and all nodes synchronized with the blockchain, PoS becomes secure and fully decentralized.
Staking ensures that the blockchain network is secure against any attack. Blockchains with more stakes are more decentralized and secure. Stakers can earn higher returns than those who invest in the financial market since they are rewarded for maintaining the integrity of the blockchain network. However, there may also be risks involved in staking, such as the fluctuation in the stability of the network.
DeFi and Staking
Decentral finance (DeFi) is an umbrella term for financial applications that uses blockchain network to facilitate trustless transactions. DeFi eliminates all the intermediaries in a transaction. For example, if one were to take a loan now, the bank would act as an intermediary by issuing the loan. DeFi, on the other hand, replaces such intermediaries with smart contracts. The ultimate goal of DeFi is to increase financial equality and reduce the time and cost of transactions. Users can access financial products such as lending, borrowing, and saving.
As an investor, there are some measures that you must take when using DeFi for staking. First, you have to consider the security of the platform. Some fraudsters use rug pulls to defraud users. Rug pull is a scenario where developers drain funds from the project before closing it down. Second, you should evaluate the liquidity of staking tokens. A token with high liquidity is easily tradable. Third, consider whether the rewards are inflationary. Inflationary tokens have no hard cap – they will continuously be printed over time hence having the risk of experiencing runaway inflation. Finally, you can consider diversifying into other staking projects and platforms as a way of spreading your risks.
The decentralized nature of DeFi platforms makes them more secure than traditional platforms since they cannot be hacked. You can stake tokens with the already established platforms such as Polkadot, and Uniswap, or even relatively new platforms that offer even higher rewards such as Hi.
What are the Differences between Yield Farming and Staking?
Yield farming and staking share the primary concept of holding funds to generate profits. Some investors even consider staking to be part of yield farming, even though this assumption is inaccurate as the concepts differ in many aspects. Here are some key differences.
1. Level of Risk
Relatively new DeFi projects often offer yield farming compared to projects offering to stake. Therefore, farming can be highly risky as they may be exposed to cyberattacks
The smart contracts may also have bugs, putting the entire system at risk. Additionally, many investors may not know how to read smart contracts hence unable to detect bugs.
Both Yield farms and staking pools also experience volatility risks. The tokens may suddenly drop in value leading to a loss in funds. Investors may also face liquidation risks when their funds are no longer enough to cover their investments.
Yield firming may offer higher rewards than staking. However, staking is relatively less risky. Risk-reverse investors might consider staking over yield farming. The risk can be even higher if the transaction fee is high.
Read more about crypto staking risks
Staking is often a simpler strategy for earning passive income compared to yield farming. You simply decide on the staking pool you want to use and then lock in your digital assets. On the other hand, yield farming may require more work as you have to choose which token to lend and on which platform. You can also keep switching tokens and platforms based on factors such as interest rates.
Yield farming on a DEX may require depositing a pair of coins in sufficient quantities to provide liquidities. The digital assets may range from native tokens to high-volume stable coins. Yield farmers then get the reward proportionate to the amount of liquidity they deposited. Sometimes it pays well to switch between yield farming pools as you can get higher interest rates (annual percentage yields – APY). In this sense, yield farming can be highly rewarding than staking. However, switching platforms often attract additional fees. Such active management in yield farming is also time-consuming and requires some level of skills.
Both yield farming and staking allow investors to gain passive income. The two methods allow for compounding, where you can reinvest your profits and keep growing your funds. Both staking and yield farming returns are measured in annual percentage yield (APY). Traditional staking in crypto exchanges has steadier APY compared to yield farming. Staking rewards typically range between 5% and 14% APY. However, some platforms such as Hi.com offer as high as 40% APY.
Yield farming, on the other may give supernormal returns, up to 1,000% APY, especially for investors who get involved early with a new project or strategy. However, the yield farming strategies may be highly risky.
4. Impermanent Loss
The fluctuation in crypto prices exposes yield farmers to impermanent loss. The investors do not benefit from the increase in the prices of digital assets. For instance, if an investor deposits funds into a liquidity pool and the crypto price soar, the investor would have been better off holding those crypto tokens rather than depositing them into the pool. You can also experience impermanent loss if the value of the investor’s tokens drops. Impermanent loss does not happen with staking.
If you seek liquidity, you can opt for staking, which offers increased return (or APY) when you lock your funds for longer periods. On the other hand, yield farming does not require investors to lock in their funds.
Yield farming offered by new protocols may pose a high risk since they are vulnerable to hackers. Some of the smart contracts running the farming pools may have bugs that cybercriminals can exploit. Staking, on the other hand, is generally more secure since investors are participating in the underlying blockchain’s strict consensus mechanism. If any user tries to trick the system, they will lose their staked funds.
7. Transaction Fees
Yield farmers who switch between liquidity pools may pay more switching costs to the normal transaction costs of the platforms. On the other hand, the cost of staking crypto is relatively low, as users do not switch between platforms. Additionally, staking does not use the resource-intensive PoW, hence the upfront and the maintenance fees are also lower.
PoS tokens are inflationary digital assets, and any yield paid to investors who stake their tokens is made up of a new token supply. Staking your tokens will enable you to receive rewards in line with inflation, proportional to the amount invested. The value of your existing assets will decrease if you just hold them in your wallet without staking them.
Yield Farming vs. Staking: Which One is Better?
Both yield farming and staking have their unique benefits for those planning short-term investments.
Staking enables investors to get rewards as soon as transaction validation is complete. Therefore, it can make a good short-term investment that generates steady profits.
However, the expected return, though steady, may be lower than active yield farming.
Yield farming, on the other hand, is suitable for investors who prefer short-term strategies. It does not require locking up funds. You can shift from one platform to another, looking for a higher APY. Yield Farming can generate more profit with a short-term strategy. However, it is a high-risk endeavor compared to staking.
You can also use staking and yield farming as long-term strategies to earn more income from digital assets.
Yield farmers can reinvest their profits back into the scheme to generate interest in the form of more cryptocurrency. Yield farming may not offer an immediate return on investment (ROI). However, it does not require the investor to lock up their money, as in the case of staking. Additionally, yield farming can be reasonably lucrative over the long term since it allows investors to jump over platforms and tokens to find higher APY. As long as you trust the network and the protocols you are using, you can do active yield farming to generate passive income. As such, yield farming could be a great way to diversify your portfolio and increase your revenue.
Also, staking is a reliable source of returns if you commit to keeping your coins for the long haul (HOLDLing). Even though active yield farming may generate more income over the long term, you must consider the cost of shifting between platforms and tokens. Additionally, staking remains the safest strategy over the long term.
Therefore, staking rewards are more stable.
What to consider in DeFi staking and Farming Platforms
The following and some of the major factors that a user must take into account selecting a platform for staking and yield farming.
DeFi protocols may be difficult to understand sometimes. The more complex the user interface, the more time you will need to use the platform successfully. You should consider a platform that you can easily use to leverage all the available features.
Hi.com allows users to easily sign-up and select the tokens they want to stake. Additionally, the process of connecting your wallet and withdrawing your earnings is also a simple one.
2. List of Supported Assets
No single platform supports all digital tokens for staking. Therefore, you should check whether the platform you are thinking of using supports your preferred tokens for staking. Hi.com supports some of the major tokens for staking. You can earn up to 5.5% staking Ethereum and up to 11% staking USDT.
DeFi platforms are autonomous; therefore, no one will refund you if you lose funds. Security is a critical factor when selecting staking or yield farming platforms. Users should review and audit the smart contract. However, suppose you are a newbie who does not know how to audit a smart contract. In that case, you can consider a platform that a reputable security company has audited and approved to be safe. For example, Hi.com announced a successful audit of its hi dollar token smart contract by CertiK.
CertiK is a blockchain and smart contract verification company that uses modern methods of testing platforms to show whether the platform is hack-proof and bug-free. Its audit goes beyond simply checking for the existing problem. It is one of the leading auditors in the industry. According to their report, Hi.com is a safe platform that offers the ultimate security of the users’ funds.
4. Interest Rate
Platforms offer different interest rates for users’ investments. You should consider a platform with the highest APY, yet one that provides the highest security for your funds. For example, Hi.com offers as high as 40% for the investors who stake hi tokens. The platform still has strong security features that ensure users’ funds and personal data are safe.
The Bottom Line
Yield farming and Staking are both great ways of earning passive income with cryptocurrency. The two concepts are still relatively new, and sometimes the terms are even used interchangeably. They both involve holding crypto assets to earn interest. One can use both short-term and long-term strategies for both cases.
Staking is a more intuitive concept, while yield farming may require a bit of strategic maneuvering to go about and rip higher profits. Additionally, the former may not be as highly rewarding as the former. However, it is more secure. Deciding between yield farming and staking may depend on your level of sophistication and what is right for your portfolio in general.