Yield farming and staking in crypto can both be effective ways to earn interest and rewards on your crypto holdings. If someone has an amount of crypto that's expendable to them, they can stake it or farm it to earn yield. While both methods can be highly rewarding, they have their risks as well.
Crypto holdings that are used for farming or staking can be exposed to hacks or scams. They also don’t allow you to withdraw those contributions if the price of the crypto you submitted goes down and you want to cash out. One method is not necessarily better than the other.
What's yield farming?
Yield farming is when a crypto holder provides liquidity to an automated market maker (AMM) or some type of crypto platform. That holder is known as a liquidity provider (LP), and the cryptocurrency that the person offers is put into a liquidity pool. A liquidity pool is essentially a large sum of funds that are locked into a smart contract. The pool will consist of funds from a number of liquidity providers.
These pools help decentralized exchanges operate, as they help provide liquidity, speed, and convenience to those platforms. In return, the liquidity providers receive earnings based on a percentage of transaction fees, annual interest, or governance tokens. Throughout the entire yield-farming process, liquidity mining occurs, which is when participants supply liquidity pools with crypto, and those providers earn tokens and fees in return.
Depending on what the platform decides to set the duration of the contract for, the pool may last for a fixed or flexible period. Pools with fixed durations may offer higher or lower annual yields than flexible pools, depending on what the AMM prefers at the time.
One of the most common rewards for yield farming is the platform’s governance token. An example of a governance token is BNB, which is the governance token for the Binance platform. Binance offers yield farming opportunities for users, allowing them to earn BNB tokens as rewards. Users can then exchange those tokens for other cryptos on the native exchange or other exchanges that accept the governance token.
A major downside to yield farming is impermanent loss. Impermanent loss is when you contribute crypto to a pool, and the price of that crypto later increases in price, but when it’s time to withdraw your contribution, you won’t gain earnings on what the price went up to. The contributions will instead remain the same value of your initial contribution.
Another downside is that the smaller your contribution is in the pool, the smaller your reward will be. This correlates with impermanent loss, because if you contributed 100 ETH and Ether’s value doubles an hour later, someone who contributes 100 ETH when it doubled will have a larger share in the pool.
What's crypto staking?
Staking is similar to yield farming, in that you’re offering your holdings for rewards. When someone stakes their crypto, they're given the chance for their stake to validate a transaction. If that stake is selected to confirm a transaction, then that person earns a reward, which is typically the token they staked or a governance token.
The more crypto you stake, the higher chance you have of being chosen. Staking helps power cryptocurrencies that use a proof-of-stake (PoS) model. The crypto you stake remains yours, but you may not be able to use it for a certain period.