By Gaurav Arora
Decentralized Finance (DeFi) has emerged as one of the fastest growing sectors in the crypto industry, allowing investors to generate passive income through innovative financial products and services. Two popular options for earning passive income in the DeFi space are yield farming and staking.
Yield farming involves locking cryptocurrencies into smart contracts to earn rewards in the form of interest or fees on decentralized lending and lending platforms. Reward rates can vary based on market demand and supply, making yield farming a potentially rewarding but risky option.
Staking, on the other hand, involves holding cryptocurrencies on a blockchain network and contributing to its security and transaction processing. In return, investors receive rewards in the form of newly minted tokens or transaction fees.
What is yield farming?
Yield farming, also known as liquidity mining, is a process whereby crypto asset holders lend or provide liquidity to decentralized finance (DeFi) protocols in exchange for rewards. These rewards usually come in the form of additional tokens or crypto assets issued by the protocol.
Yield farming allows investors to deposit funds into a DeFi platform or protocol, just like a savings account, where you deposit your funds in a bank and receive interest in exchange for the funds deposited. However, unlike the banking system, DeFi uses smart contracts where the deposited crypto is automatically invested and the user starts earning interest.
What is De-Fi staking?
In the DeFi space, staking usually comes in two categories. One is in the form of proof-of-stake blockchains, where users contribute their crypto assets for network consensus and validation. In the second form, the user stakes Liquidity Pool (LP) tokens, which are earned while injecting liquidity into the DEXs. As a result, users can earn returns twice, once for providing liquidity in LP tokens, which can then be further deployed to earn more returns.
Staking is considered a universally safe way to generate passive income in DeFi by validating crypto transactions. The initial investment required with staking is lower, making it accessible to many investors. Fixed interest rates are another benefit of the staking process, helping investors calculate profits when depositing funds.
How yield farming works
Yield farming begins with the process of creating a pool of crypto assets. To facilitate this, the following steps are taken DeFi Yield Farming:
- Liquidity Pool: Creating a liquidity pool is the first step in yield farming. Investing and borrowing within specific yield operations are facilitated through intelligent contacts.
- Depositing Assets: Users can connect their digital asset wallet to deposit assets within the liquidity pool. This process, also known as staking, is like depositing users into their bank accounts or investing in a mutual fund.
- Smart Contracts: Smart contracts, which are self-executing computer code, enable various processes, such as:
- Rewards: Once you join the liquidity pool, you start earning rewards in the form of interest, which varies by yield farm. The bonuses can be paid out at regular intervals or at a later point in time in the future depending on the agreed conditions.
How staking works
Staking is about holding cryptos on a blockchain network and contributing to its security and transaction processing.
Here are the steps to understand how staking works:
- Users lock their crypto assets to a blockchain network for a specified period of time.
- Stakers set up individual nodes to validate transactions and add new blocks to the blockchain.
- Staking ensures the security of a proof-of-stake blockchain network and helps protect it from malicious actors.
- Validator nodes are randomly chosen by the network, and stakers with high-stake nodes have a greater chance of validating transactions and earning rewards.
- Users earn a percentage of the platform fee and network tokens for adding each new block to the blockchain.
It is important to note that DeFi staking and yield farming involve risks such as smart contract and market volatility. Therefore, it is important to do proper research and understand the risks involved before engaging in yield framing and DeFi staking.
The author is SVP, DeFi Initiatives, CoinDCX
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