Key Takeaways:
- Staking is generally associated with single-sided deposits to secure networks and blockchains
- Yield farming usually comes in the form of incentives to attract TVL
- Both have advantages and some aspects have started to overlap in DeFi
___________________________________________
Too often, the terms “staking” and “farming are used interchangeably. Did you know, however, that they are not the same?
To answer what the key differences are, we must first dive into what is Decentralized Finance, or DeFi.
DeFi is a term for a variety of financial applications built on top of the blockchain, designed to replace traditional banking systems.
It also brought about an abundance of complex financial use cases, framed as “Money Legos”
DeFi also birthed some of the hottest trends in the crypto world — in this case staking and farming. Both allow investors to earn attractive returns. So what’s the difference?
Also Read: Market Cycles In Crypto: How To Identify Tops and Take Profits
Understanding Staking
Staking is one of the many ways users can earn passive income in the DeFi world. Staking involves locking up a token in a smart contract and in turn receiving rewards.
It is akin to buying a bond and getting coupon payment in return for the deposit.
Many networks and blockchains also use staking as a method to achieve consensus.
Known as Proof-of-Stake blockchains, users can lock up their tokens with a validator node in order to secure the network. They are then rewarded with a respective cryptocurrency should they successfully participate in network validation.
Today, staking’s use cases have evolved, particularly in protocols like GMX.
By “staking” $GMX/$GLP, you provide liquidity to a decentralized market maker, instead of securing a network.
Due to the service you provide, however, you are still rewarded in a basket of tokens such as $ETH or $AVAX.
Understanding Yield Farming
Yield farming came to the spotlight in 2020’s DeFi summer. With endless farming opportunities and insane 5 digit APYs, users were clamoring for a piece of the DeFi pie.
Avalanche Rush and Olympus DAO were two key players, where users were essentially rewarded in free tokens for simply participating.
Today, DeFi has evolved so much that there are multiple platforms and ways to farm yield.
The traditional way to farm yield is through providing liquidity into a protocol. It is essentially committing a cryptocurrency pair into a liquidity pool in exchange for yield.
Liquidity providers are then able to earn a percentage of the pool reward based on the amount they contributed to the pool.
The most common examples include exchanges such as Curve and Uniswap.
In return for providing liquidity to the protocol, liquidity providers earn trading fees and crypto rewards from the platform. Rewards are usually distributed based on the proportion of liquidity they contributed to the pool.
These farms can also be further incentivized through programs, airdrops or even “bribes”, where liquidity providers can earn even more rewards.
Key Differences Between Farming and Staking
While some may still see both terms as interchangeable, let us go through some key differences in their fundamentals.
First, yield farming generally leads to more dilution than staking.
They high APYs provided are usually required to attract liquidity. The downside, however, is that these same APYs usually inflate a token’s circulating supply, pushing prices down.
Secondly, yield-farming usually attracts capital for shorter periods of time. Due to the yield eventually drying out, “mercenary capital” usually rotates into these farms and leave when rewards decline.
In contrast, staking rewards usually derive from some form of service provided. While they may also be dilutive, the less competitive APYs usually means only those who wish to participate in the ecosystem will be keen to stake.
Thirdly, yield-farming often leads to impermanent loss, as it normally requires you to deposit a liquidity pair. Examples include Uni-ETH, Sushi-USDC, and BTC-AVAX.
By depositing a pair of cryptocurrencies, you gain exposure to potential losses should a large move in either asset occurs.
Staking, however, is usually concerned with single-sided deposits, and therefore has no exposure to impermanent loss. That is not to say that you will never suffer losses; if the token’s price goes down, you will still be have lost money regardless.
Despite this, several platforms now offer single-sided staking for liquidity pairs, a hint at the progress of DeFi.
Closing Thoughts
While the differences between staking and yield farming seem minute, acknowledging them helps clarify a lot in the Web3.0 ecosystem.
However, some forms of staking may fall under yield farming and vice versa. At the speed that DeFi is progressing, these lines may get increasingly blurred, and more clarifications may have to be made in the future.
As for which is better, it really depends on the individual investor. Both approaches cater to different kinds of crypto participants, and therefore due diligence has to be done when trying to earn additional rewards on your crypto.
Also Read: The Lazy (But Effective) 5 Step Process To Doing Your Own Research In The Bear Market
[Editor’s Note: This article does not represent financial advice. Please do your own research before investing.]
Featured Image Credit: Chain Debrief
