Yield Farming vs Staking Vs Liquidity Mining – What Will Be Your Secret to Success in DeFi?

Note: This blog is written by an external blogger. The views and opinions expressed in this post belong solely to the author.

There is no denying that the DeFi sector is expanding. As new decentralized finance solutions emerge, companies and individuals alike are keen to capitalize on them. Decentralized finance has not only improved financial inclusion around the world, but also made digital assets more accessible and easier to manage.

Differences between staking, yield farming, and liquidity mining often come up when talking about DeFi trading. As far as DeFi solutions go, they are all popular options. Participants are each required to otherwise pledge their crypto assets in decentralized protocols or applications.

Another indication of differences between the three approaches can be found in the underlying technologies. In the discussion below, you can learn more about DeFi’s three main approaches to earning profits from your crypto assets. You can learn yield farming and the other two strategies together to see possible differences between them.

Participants in all three DeFi trading strategies are required to pledge their assets in support of a decentralized protocol and application. However, the underlying nature of each of these channels has always been different.

Let’s start by taking a look at these.

Yield Farming – DeFi’s Apple of Eden

Yield farming is the most common way to profit from crypto assets in the DeFi space. Depositing crypto into a liquidity pool is a passive way to make money. Centralized Finance (CeFi) equivalents of these liquidity pools can be thought of as where you keep your money and your bank uses it to lend it to others and pay you a portion of the interest it earns.

A smart contract based liquidity pool like ETH/USDT is a type of yield farming where investors lock their crypto assets into the pool. Users in the same log can now access the assets that were previously locked to them. Lending protocol users can borrow these tokens for margin trading.

DeFi protocols that offer exchange and lending services build on the foundation of yield builders. Because of this, decentralized exchanges are able to maintain a stable supply of crypto assets (DEXs). Yield farmers are compensated for their efforts in the form of APY.

Understand yield farming

As an alternative to traditional order books, yield farming relies on automated market makers (AMMs). It is possible to trade digital assets using AMM contracts, which are smart contracts that use mathematical algorithms to do so. The fact that they do not require a counterparty means that consistent liquidity is maintained.

Liquidity Providers (LPs) and Liquidity Pools

Both liquidity providers (LPs) and liquidity pools are essential to an AMM.

• The DeFi marketplace is powered by smart contracts known as Liquidity Pools. The digital funds in these pools allow users to easily buy, sell, borrow, lend, and exchange tokens with each other.

• The LPs are the investors who put their money into the liquidity pool and are rewarded for it.

Yield farming is also a lifeline for low-volume tokens in the open market, allowing them to be traded with ease.

Risks in yield farming

Only by being aware of the risks associated with each type of investment can one better understand their differences. Investing in generating returns can be risky but also rewarding. Permanent loss, smart contract risk, composability risk, and liquidation risk are some of the key risks associated with yield farming.

Then there is the issue of token volatility. In the past, the price of cryptocurrencies was known to fluctuate. When a token is locked into a liquidity pool, its price can rise or fall in short bursts depending on how volatile the market is. Because of this, it’s possible that you’re worse off than if you had your coins ready to trade.

Why should you use Yield Farm?

To put it bluntly, yield farming is about hefty profits. For example, early adopters of new projects could earn tokens that could quickly increase in value. You can either reinvest the money or reward yourself with it.

Both yield farming and regular banking currently have advantages and disadvantages. Interest rates can fluctuate, making it difficult to predict your returns over the next year — not to mention that DeFi is a riskier environment to invest your money in. However, if you don’t want to get stressed out about day trading, yield farming is the way to go.

Staking – The future of consensus protocols

Staking is a term used in cryptoeconomics to describe how you deploy your crypto assets as collateral to blockchain networks using the PoS (Proof of Stake) consensus mechanism. To validate transactions on Proof-of-Stake (PoS) blockchains, stakers are selected similarly to how mining facilitates consensus on PoW (Proof of Work) blockchains.

PoS is often preferred to PoW because it is more scalable and energy efficient. Stakeholders can benefit from PoS by earning rewards. The more coins a staker has, the more likely he is to produce a block at PoS.

The more stake you have, the greater the network’s reward for the stake. When you stake your cryptocurrency, you will receive new tokens of that currency whenever a block of that currency is validated. Staking, rather than mining, is a more practical technique for reaching consensus. Miners don’t need expensive equipment to generate the computing power they need. In addition, staking platforms make the practice of staking more convenient.

When it comes to passive investing like yield farming, staking has a reduced risk factor. The security of staking tokens is identical to the security of the protocol itself.

Risks in staking

One of the key considerations in debates about whether to stake, farm, or mine is the risk associated with proof-of-stake techniques. Staking has lower risk than other passive investing methods, which is an interesting fact to consider. There is a clear connection between the security of the protocol and that of the tokens used.

However, there are still risks associated with cryptocurrency staking such as slashing, volatility, validator and server risks. In addition, you may have to contend with difficulties such as theft or loss of funds, incentive waiting times, project failures, liquidity risks, minimum inventory levels, and extended lock-up periods.

Why Use Your Crypto?

First off, staking is a great way to earn more cryptocurrency, and interest rates can be extremely high. In some cases, you may be able to earn more than 10% or 20% each year. It has the potential to be a very lucrative investment strategy. Furthermore, the proof-of-stake model of crypto is all that is required.

The blockchain of the cryptocurrency you invest in can also benefit from staking. To authenticate transactions and keep the network efficient, many cryptocurrencies rely on staking by holders.

Liquidity Mining – The life force behind DeFi

There is no DeFi project without liquidity mining. Its main goal is to provide liquidity to the DeFi protocol. Participants in this investment method contribute their crypto assets (like ETH/USDT trading pairs) to the liquidity pool of DeFi protocols for crypto trading (not for crypto lending and borrowing). The Liquidity Provider Token (LP) is given in exchange for the trading pair. This in turn is used for the final repayment.

As long as the user’s tokens are still in the liquidity pool, the protocol compensates them with native tokens (or governance tokens, GOV) that are “mined” in each block on top of the LP already earned. They receive a reward percentage based on their share of the pool’s liquidity. These newly generated tokens not only give the liquidity miners access to run the project, but can also be exchanged for better rewards or other digital currencies.

Understand liquid mining

Liquidity mining differs from other crypto investment techniques. It depends on how it works. In exchange for the tokens they put into the liquidity pool, investors would be rewarded by the protocol. The native governance tokens mined at the end of each block are the reward for liquidity mining.

In the first phase of locking the crypto assets, investors will receive the LP token as a bonus. Liquidity mining rewards are directly proportional to the amount of total pool liquidity, which should not be underestimated. Newly issued tokens could potentially provide access to a project’s governance, as well as the ability to exchange them for other cryptocurrencies or higher benefits.

Risks in Liquidity Mining

Staking, yield farming, and liquidity mining all have their own unique risks, and it’s important to understand those risks. Like the other two methods, liquidity mining has some major downsides, including the possibility of volatile losses, smart contract risks, and potential project risks. The rug pull effect can also affect liquidity miners, making them vulnerable.

Why should you choose Liquidity Mining?

In liquidity mining, your return is directly correlated to the risk you are willing to take, so the investment can be as risky or as safe as you choose. Beginners will have no problem getting started with this investing plan because it is so easy to get started.

Although liquidity mining is a relatively new investment technique for crypto assets, it seems like it will be around for a long time. Liquidity mining can be a good option for you if you are looking for an investment strategy that will serve you well in 2022 and beyond.

To sum it up, here’s a quick comparison chart:

Data collected by blockchain-council.org

Final Thoughts

Ultimately, liquidity mining is a component of yield farming, which in turn is a component of staking, and so on. You can put your crypto assets to good use in one of these three ways. Liquidity mining helps the DeFi protocol by providing liquidity, while yield farming seeks to maximize yield and staking aims to maintain the security of a blockchain network. In the end it’s all up to you. Whichever route you choose, however, make sure you are prepared with the right understanding of the approach. DYOR is the mantra.

Disclaimer: Cryptocurrency is not legal tender and is not currently regulated. Please ensure that you carry out an adequate risk assessment when trading cryptocurrencies as they are often subject to high price volatility. The information provided in this section does not constitute investment advice or the official position of WazirX. WazirX reserves the right, in its sole discretion, to add to or change this blog post at any time and for any reason without prior notice.

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