> Blog > Yield Farming vs. Staking Crypto

Published July 21, 2022

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The crypto ecosystem is filled with different ways to use money as a vehicle to compound it for larger returns. Decentralized finance, or DeFi, has opened the floodgates for financial innovation, and developers are coming up with new and unique ways for users to leverage their money and put it to work passively. Two of the most popular ways to do this is through staking and yield farming. For many, these practices can feel daunting at first, especially when it involves your own money, but in reality, staking and yield farming can be done relatively safely and effectively as long as you take the necessary precautions.

Let’s dive into what these practices are and discuss how you can use them to take their portfolios beyond what they thought was possible.

What is Yield Farming?

Yield farming is a DeFi process that leverages user funds to maximize their returns. By utilizing smart contracts, participants can lend out or borrow their crypto on various DeFi protocols and receive a reward for offering up tokens for other users’ various needs.

Yield farmers will take their tokens and store them in a decentralized application, or dApp. There are all kinds of different dApps out there, like digital wallets, decentralized exchanges (DEXs), play-to-earn games and more.

Yield is calculated by two popular measurements: annual percentage rate (APR) and annual percentage yield (APY). The only difference between the two is that APY measurement accounts for compounding gains while APR does not. Keep in mind, though, that while a dApp may present a particular APR or APY for farming tokens, those rates are subject to change over time as users enter and exit the platform. As a general rule of thumb, the yield rate will drop when more users jump into a particular yield farm, whereas yield rates will rise when more users exit the platform.

There are three roles to play when considering yield farming:

  • Liquidity provider: This participant deposits equal amounts of two different tokens into a DEX’s liquidity pool (LP) to add liquidity for traders. As traders on the DEX swap between those two particular tokens, the DEX accumulates trading fees and pays them out to the liquidity providers for their service. Compare this process to a typical centralized exchange like FTX: FTX provides its own liquidity for traders, and as traders swap tokens on the exchange, FTX collects these fees and uses them to keep the exchange operating. DEXs act in the same role as FTX, however, the fees are paid out to the liquidity providers, rather than a centralized company. DEXs enable anyone to become a liquidity provider and passively earn yield by providing their assets for traders to swap between.
  • Lender: Using smart contracts, lenders earn yield by lending out their crypto to borrowers and collecting interest paid to them by the borrowers of their assets.
  • Borrower: A borrower puts down their own tokens as collateral and uses the tokens lent to them to plug into other DeFi platforms that farms yield for them. This enables borrowers to benefit from the potential price appreciation of their collateralized assets as well as farm yield from the tokens that they are borrowing.

Advantages of Yield Farming

The primary advantage of yield farming is earning passive income. Instead of actively trading, you can take your assets and plug them into DeFi platforms to accumulate yield over time.

Another advantage of yield farming is that it takes less time. While it doesn’t gather as immediate of returns as compared to trading, it requires no management after plugging them into the smart contracts. This makes yield farming ideal for assets which you may have a long-term investment horizon for. You can plug their tokens into a yield farm and accumulate more tokens over time – if it turns out to be a successful project, yield farming can be immensely profitable.

Disadvantages of Yield Farming

One of the disadvantages of yield farming is the potential for impermanent loss. Since liquidity providers offer up two separate tokens into a smart contract, there is a discrepancy between the price of each of the assets. If one of the token’s prices moves drastically relative to the other token in the liquidity pool, you may face impermanent loss, meaning that you will get less out of the pool than what you initially put in. It is therefore very important to keep an eye on the health of each project’s token and act accordingly in case of volatile market conditions.

Another potential risk is fluctuating interest rates. Lenders rely on interest rates to earn consistent yield on their tokens, however, if the particular asset being lent experiences a sharp increase in supply, interest rates for that asset may drop as a result.

One other risk of yield farming is liquidation. Borrowers who use their tokens as collateral for borrowing lent assets may be liquidated in case of a sudden drop in the price of their collateralized tokens.

What is Staking?

Staking is another way in which you can passively earn income on your crypto, but it comes with a few key distinctions that you should consider before trying out themselves.

You can stake their assets and earn interest on them through two primary methods: proof-of-stake blockchains and liquidity pool staking. Staking assets on proof-of-stake blockchains like Solana or Avalanche is the primary and straightforward way in which users stake crypto. By staking tokens on the blockchain, it provides greater security to the network, and stakers are paid interest as a reward. This is in contrast to proof-of-work blockchains like Bitcoin, which secures its network by using physical miners that consume energy to solve mathematical puzzles in order to prevent bad actors from manipulating the blockchain.

The other form of staking tokens is through liquidity pool staking. As liquidity providers earn yield from supplying a DEX with liquidity, they can take those earnings and stake them in a DEX to earn even more yield on top of their LP tokens.

Advantages of Staking Crypto

Similar to yield farming, the obvious advantage of staking tokens is earning passive income. As tokens are staked, they accumulate interest paid out in the staked token. If the asset appreciates over time, you can passively multiply their returns by accumulating more tokens over time.

Also similar to yield farming, staking is low-maintenance, and actually comes with less risk than yield farming. Staking only takes a couple of initial steps to set up, and once tokens are staked, there is no need to worry about impermanent loss, since you are only staking a single asset as opposed to two.

One more advantage of staking is that it supports the network that you are staking on. By staking tokens, you are ensuring that the network operates smoothly and that transactions can be verified with no interruptions.

Disadvantages of Staking Crypto

The biggest disadvantage to staking tokens is the potential volatility that comes with the crypto markets. If the price of a staked token drops significantly, it can outweigh any amount of interest earned through staking.

Another downside to staking is the potential lock-up times that come with it. Some blockchains require you to lock up their coins for a minimum amount of time when initially staking. They may also enforce an unstaking period which can take various amounts of time, from seven days, to 21 days, or even more. Some staking methods don’t require any lock-up time, so be sure to read the details and requirements involved before staking any tokens.

Staking vs. Yield Farming: How Do They Compare?

As a general rule of thumb, simply staking tokens is the quicker and easier way to earn straightforward interest by securing the blockchain’s network. However, by taking a few more steps to yield farm, users tend to generate more yield than traditional staking methods. That extra yield can come with greater risks, of course, so be sure to do plenty of research before hastily putting money anywhere. As it applies to all walks of life, but especially in crypto, greater rewards always carry greater risks.

Keep these comparisons in mind when choosing which passive income method is best for you:

Yield Farming vs. Staking Crypto: Summed Up

Yield farming and staking crypto are both great methods to put extra money to work and earn yield for ensuring DeFi operations can run smoothly. While they each have their own benefits, they each carry different risks to consider as well. Be sure to do ample research into both strategies before making any decisions, and never invest more than you are willing to lose into any staking or yield farming protocol.

FTX.com is one of the best centralized exchanges to trade crypto. And as an added bonus, if you buy and stake the FTT token, you can enjoy lower trading fees, free withdrawals, and more.

FTX prides itself on keeping effective altruism at the front of mind. With each trade, a percentage of the fees get invested into humanitarian-focused projects in an effort to maximize the amount of good the platform can bring to the world. Sign up for an FTX account today or consider joining the FTT DAO to support the exchange on its mission to foster effective altruists throughout the world.

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