Staking V/S Yield Farming V/S Liquidity Mining: Key Differences
As DeFi becomes a popular way to earn a crypto income, there are several ways those income streams are defined, just like in the traditional market where you can earn in regular trades, derivatives, and many more.
Similarly, in DeFi, Staking, Yield Farming, and Liquidity Mining are considered the ways to earn cryptos.
But the thing is, all these methods work similarly. So anyone who just came across to know about cryptos and DeFi would end up in confusion about the exact differences between Staking, Yield Farming, and Liquidity Mining.
In this post, I’ve highlighted some key and important differences in Staking, Yield Farming, and Liquidity Mining. So you do not end up in confusion.
What Is Staking?
Staking means pledging your crypto asset in the blockchain to earn rewards in return for validating the transaction on the blockchain.
There are several consensus mechanisms crypto blockchains follow. For example, Proof-Of-Work (POW) consensus is followed by the famous cryptocurrency Bitcoin, where miners validate the transactions and fetch them into a block, then add the block to the blockchain; in return for their work, miners earn a certain amount of Bitcoin as a reward.
Likewise, in the Staking method, adopted by the Proof-Of-Stake (POS) consensus, you stake a certain amount of crypto assets in the blockchain and become a validator whose work is similar to the miner, validating transactions and adding blocks to the blockchain.
Your staked amount becomes proof to validate the transaction, and the network chooses validators based on the size of their stake and the length of time they’ve held it. So the most invested participants are rewarded.
The POS consensus made blockchain more scalable and energy efficient because, in POW, miners need high-capacity computer hardwares to mine. But in staking, one needs to stake a certain amount of crypto assets.
Even in staking, if transactions you’ve validated in a new block are discovered to be invalid, a certain amount of your stake is burned by the network, which is known as a slashing event.
What Is Yield Farming?
Yield Farming is the popular way to earn cryptos in DeFi.
Yield Farming is done through DeFi protocols which offer interest payment along with some tokens as a reward in exchange for depositing a certain amount of crypto assets on the protocol.
The whole DeFi system is decentralized, not depending upon any servers. So to do any trading activity, protocols needed upfront liquidity which is provided by the liquidity pool where anyone can deposit crypto assets, and the pool collects all the funds and provides them to the protocol to do various DeFi activities.
In return for providing the liquidity, protocol incentives, a percentage of transaction fees collected by the pool for facilitating trades, interest from lenders, or a governance token. These returns are expressed as an annual percentage yield (APY). APY is the rate of return gained over a year on a specific investment. Compounding interest, which is computed regularly and applied to the amount, is factored into the APY.
The game is not over by just receiving high APY. To further maximize return, liquidity providers use many strategies, like using governance tokens provided by the protocol on other liquidity pools to receive more APYs or using stable coins and crypto assets like USDC/ETH to provide liquidity to the pool to take advantage of market movement and limiting the risk or swapping token from one protocol to another and receive a higher fee.
Yield Farming is a high-risk, high-reward game where many risk factors are involved, like DeFi protocols can have bugs and malfunctions initially when launched that could be ended up prey for a hacker, or the project can promise high APY and collect huge deposits and finally run away, or the main risk is the crypto market is volatile, and many strategies of yield farming are dependent upon the market so if the market suddenly collapses may end up taking a loss.
What Is Liquidity Mining?
Liquidity Mining is another form of lucrative opportunity to earn crypto income passively in the DeFi ecosystem.
Decentralized exchanges use the Liquidity Mining strategy to attract liquidity. The process is simple in a decentralized exchange liquidity pool; one can deposit their crypto holding and receive an LP token as proof for the deposit along with the fee, which is proportional to the quantity deposited to the liquidity pool.
The whole process looks like POW crypto mining, where a miner earns a reward and creates new coins, but the benefits received from the liquidity provider do not just end when receiving the reward; for example, if you provide liquidity to a decentralized exchange, most likely you’ll receive LP is in the form of their own native token which gives you the authority to govern the platform in any way of decision making.
Liquidity Mining has some drawbacks like a decentralized exchange could have some bugs or vulnerabilities which can lead to hacking, or the entire platform is created to just take the money and run away, or you can face some drastic price fluctuation on the market leading to an impairment loss.
Difference Between Staking, Yield Farming, and Liquidity Mining.
| Staking. | Yield Farming. | Liquidity Mining. |
|---|---|---|
| Staking is done on the Proof-Of-Stake blockchain, also with many centralized platforms like BlokFi, and Nexo. | Yield Farming is done on the different DeFi protocols supporting AMM (Automated Market Maker). Like lending, borrowing, and even swapping cryptos to other exchanges. | Liquidity Mining is done on decentralized exchanges where smart contracts manage liquidity pools. |
| Staking on the blockchain gives the privilege to validate transactions and earn the reward for it. | A reward is calculated in APY on the asset locked by the participant. | Rewards in the form of LP tokens along with the fee proportionate to the number of locked funds in the pool. |
| Staking is not a high-risk game, so it is a suitable strategy for a beginner or a low-scale investor. | Yield Farming is a High-risk and High-reward game that provides a quick and short-term return. | Liquidity Mining falls in the middle because it does not involve high risk or provide quick returns, nor is it suitable for beginner-friendly investors. |
| Under this strategy, investors face risks like: ● Extended Lock-up periods. ● Long waiting periods for rewards. ● Loss or theft of funds. ● Liquidity, validator, volatility risk. | In Yield Farming, risks are: ● High-risk, High-reward game. ● Impairment loss. ● Platform risk. ● Liquidation risk. | Liquidity Mining involves risks like: ● Rug pull projects. ● Smart contract risk. ● Impairment loss. |
Conclusion.
Staking, Yield Farming, and Liquidity Mining are great ways to generate crypto income.
Each of them has its own advantages and disadvantages, so it is up to you to choose the best suitable strategy.