What Is Yield Farming? Difference Between Yield Farming and Staking
If you’re dwelling in the crypto world like me then you’ve heard about the DeFi movement where DApps created to manage all financial activities like central authorities such as Banks do.
Some intelligent brains took advantage of the DeFi movement to multiply their investment; this multiplying process is well known as Yield Farming.
So what is Yield Farming? Can anyone make more money using Yield Farming? Is Yield farming a better option than staking cryptos?
Before finding any answers, firstly, you have to understand what actually Yield Farming is.
What Is Yield Farming?
Yield Farming is a strategy that a person AKA Yield Farmer uses to maximize the rate of return on capital by leveraging different DeFi protocols.
In plain English, Yield Farming is the different set of strategies used by the Yield Farmer to maximize profit on capital invested using the DeFi platform like Compound, Aave.
Here farmers use different sets of strategies to maximize the rate of return because everyday DiFi platform interest rates fluctuate, some strategies work today but not work for tomorrow, so there are no fixed rules or plans to maximize gains.
Let’s look at the example to get a better understanding.
To Yield Farming, first, you need a DeFi lending platform like Compound, which allows you to lend and borrow tokens.
On the platform, you have to lend the token that gives you the highest annual interest rate. Let’s say you lend $100 worth of token A for 13% annual interest on the platform.
When you successfully supply the token to the platform, the platform also allows you to use your supplied tokens as collateral to borrow other tokens, so you took the opportunity and chosen to barrow token B, which has the lowest interest rate of 1% with the exchange of token A’s 60% which is worth of $60 as collateral to borrow token B.
Now you have the $60 worth of token B in your account with an annual interest rate of 1%.
It’s time to do Yield Farming, now you have to go to any decentralized exchange to convert token B into token A when you successfully converted the token, again you deposit the token to the lending platform to earn the interest rate and use it as collateral to borrow token B you can repeat this process as many time, and each time you lend and borrow you receive more interest rate than you pay for borrowings.
Also, in the process, you have to look after the interest rates for both borrowing and lending because interest rates fluctuate every day, so you have to look for different pairs of tokens and also make new strategies each day.
Above is one example of how Yield Farming is done using different DeFi platforms.
History of Yield Farming.
Yield Farming started when the reputed DeFi lending platforms started to issue governance tokens in 2020.
Compound is the first DeFi platform to issue their governance token COMP.
Platform wanted to encourage both depositors and borrowers to use COMP and also help to make lending easy.
COMP token price shot high immediately, resulting in borrowers making huge profits taking the COMP loans. Soon other platforms like Balancer, Curve, Aave followed Compound.
This incident encouraged more people to join the platform and make huge profits by taking advantage of the gap in the interest rate.
Difference Between Yield Farming and Staking.
Before jumping to differences, look at what actually staking means for getting a clear picture of both concepts.
Although staking is an old concept and most crypto enthusiasts familiar with it, I also wrote a dedicated post on stacking AKA Proof-Of-Stake(POS).
Anyway, POS is the consensus mechanism like Proof-Of-Work (POW) which used by Bitcoin where miners validate the block using their hardware power in return get the reward, but in POS, there are no miners involved in the process instead validators who deposit a certain amount of coins to the network selected to mine the block, in return, they collect network fee as a reward so more coins validator deposit they get more opportunity to mine a block.
Now, look at actual differences between Yield farming and staking.
| Differences. | Yield Farming. | Staking. |
|---|---|---|
| Profit. | While doing Yield Farming, one can earn up to 100% return even with an excellent strategy. Even more than 100% return is achievable. | In staking, funds are locked in the blockchain, and APY (Annual percentage yield) rates payout every year ranging between 5% to 15%. |
| Reward. | The exact rewards are determined by a platform liquidity pool’s APY and interest rate that changes along with the pool’s activity and token value. | Rewards are given for actions that help the network reach consensus. |
| Security Risk. | In the DiFi world, everything runs on smart contracts, some platforms made Yield Farming automated using smart contracts. Smart contracts tend to be poorly coded by inexperienced teams, which results in security vulnerabilities that are exploited by ‘hackers’. | Staking is done on the blockchain, one of the secure environments in the world. In fact, if a staker stops confirming transactions or conducts other malicious activities, their assets can be taken away. |
| Impermanent loss. | Impermanent loss is a loss occurring to farmers when there is a huge price gap between holding and staking assets. For example, while doing Yield Farming for depositing every single token A, you get 100 token B in return, but if a token A price rises suddenly by doubling its worth, then you can make a profit just holding assets than doing Yield Farming. | In staking, there is no such impermanent loss risk because assets are locked in blockchain for a certain period; if in that period the entire industry enters into the bear market, you’ll receive a percentage fee for staking assets. |
| Time Lock. | There are no time locks or any thresholds to invest and hold the assets on any platform. | Here some projects enforce to stake a certain amount of assets for a specific period of time. For example, in Etherium 2.0, a staker must stake at least 32 ether and also require some technical aspects to meet. |
Conclusion.
Yield Farming and Staking both have their pros and cons, so you have to consider all the aspects before stepping into one of them.
Using smart ways, you can utilize both concepts to make profits, for example, using insurance coverage platforms to secure the asset in Yield Farming or choosing the right network to stake the asset.
Now it’s your turn to choose the best one for you.
Tell me which one you prefer.