As the DeFi universe paves its way further, more and more earning possibilities emerge. However, the two primary ways of passive income align close to each other as both remain popular choices for millions of crypto users: yield farming and staking. But which one wins the battle?

In this article, we will compare yield farming and staking, discover their benefits, security patterns, and factors to consider while choosing a platform for passive crypto earn. Therefore, follow along to unleash farming and staking in more detail and apply the gained knowledge.

What is Yield Farming?

Yield farming, also known as liquidity mining, is a practice within the decentralized finance (DeFi) ecosystem where cryptocurrency holders can earn rewards by providing funds to liquidity pools on various DeFi platforms. The concept revolves around maximizing the return on investment by leveraging different DeFi protocols and mechanisms. Liquidity plays a vital role in yield farming as it activates rewards and is a source for the exchange execution of the decentralized platform.

Liquidity Providers & Pools

In traditional financial systems, liquidity is provided by banks and financial institutions. In DeFi, liquidity pools are created where users deposit pairs of cryptocurrencies (usually one stablecoin and one other cryptocurrency) into a smart contract. These pools facilitate trading on decentralized exchanges (DEXs) like Biswap.

Once a user has supplied liquidity to the pool, he becomes a liquidity provider and gains rewards for the conducted assets’ provision. That’s where AMM (Automated Market Maker) meaning and influence come into play. The liquidity distribution into the pool and its earning process is quite different on the AMM V2 and V3 protocols of the decentralized platform.

Let’s take Biswap DEX as an example and see how old and new protocols impact liquidity provision.

V2 AMM Protocol: Liquidity Provision & Crypto Earn

While providing liquidity via AMM V2 protocol, liquidity providers get LP tokens in return, representing their pool share. Then, they may stake their LP tokens to active Farms and launch a passive income. Despite farming opportunities, investors automatically gain a certain percentage of the trading fees as an LP rewards for their provision. The liquidity on AMM V2 protocol is provided on a full-price scale and can’t be managed by the provider. That’s the main difference, as on AMM V3, the investor can concentrate and control liquidity.

V3 AMM Protocol: Concentrated Liquidity & Capital Efficiency

V3 AMM allows Biswap Liquidity Providers to deposit their crypto for a particular price interval by setting a price range. Users can have one or multiple positions with the same or different price ranges for a liquidity pair. It means that liquidity will be used within a specific price interval, where most trades occur, instead of being distributed along the price curve between 0 and infinity. Liquidity Providers can decrease the impermanent loss by narrowing the price range, thereby preserving a portion of their capital. It also depends on users’ strategy, range size, and other factors.

On this protocol, providers earn from Farms(if available for a liquidity position) and 80% from trading fees while their liquidity remains active in a chosen price range. Find out more about beneficial V3 offers for traders and liquidity providers。

Calculate Your Earnings by Using APR & APY

Proficiency in determining your earnings is a fundamental skill. Two metrics employed for this purpose are APY and APR. Both metrics also influence the amount you’ll accumulate from saving or lending your cryptocurrency assets.

APR — Annual Percentage Rate

APR doesn’t consider compound interest. In other words, the user stakes a particular number of crypto assets at a certain rate of return. In this way, the user’s income is accumulated separately from the principal amount.

For example: the user staked 1000 LPs under 50% APR. That means that at the time of calculation, your income for 1 year can be calculated as follows:

1 000 LPs (the invested sum) x 50% (APR) = 500 LPs — your 1-year income.

In this case, the user’s 1-year total sum potentially can be:
1 000 LPs (the unstaked sum) x 500 LPs (the income in APR) ~ 1 500 LPs.

APY — Annual Percentage Yield

Unlike the APR, the APY takes into account compound interest. It means that the specific amount of crypto assets the user staked increases every payout period, adding the earlier earned interest to the invested sum. Depending on how often the APY is compounded, it changes.

For example: A user has staked 10 LPs of $1000 value at 50% liquidity provider APR. This means that at the time of calculation, his 1-year income can be calculated as follows (without taking into account an impermanent loss): $1000 (invested amount) x 50% (APR) = $500 — income for 1 year.

In this case, the user’s total for 1 year could potentially be:
$1000 (the unstaked sum) + $500 (the income in APR) = $1500

But keep in mind that the amount of LP tokens is still 10. That happens because your earnings as a liquidity provider are automatically added to your LP tokens.

Benefits of Yield Farming in the Decentralized Industry

• High Potential Returns: yield farming can offer significantly higher returns compared to traditional savings accounts or even other investment options in the cryptocurrency space.
• Diversification: yield farming allows users to diversify their holdings across various DeFi protocols and platforms, potentially mitigating risk.
• Liquidity Provision: yield farmers contribute to the liquidity of decentralized exchanges and lending platforms, facilitating smoother trading and borrowing experiences for the broader crypto community.
• Customizable Strategies: yield farming strategies can be tailored to individual risk preferences and financial goals, allowing for a range of approaches from conservative to more aggressive.

Things to Note | Pitfalls of the Yield Farming

Yield Farming is profitable yet kind of a complicated process. As on any path, you will also encounter situations you need to know about before starting. So, what are those pitfalls you may face?

Volatility of the Market
Volatility is the change of crypto value in one or another direction. It means that your locked assets’ price can swing over a short period of time. It can drop or rise, so you can’t fully control or analyze the profit you’ll get. In other words, investors might experience impermanent loss.

Impermanent Loss
There are periods when the volatility of the market is high. At this time, the liquidity providers can get through the impermanent loss. So, this is when the liquidity provider temporarily loses his funds. So, if you decide to withdraw your funds from the volatile trading pair, the value of one of the tokens can be worth less than it was deposited.

Find out more about impermanent loss here

Rug Pulls
It is a form of scam that occurs when developers collect the investors’ funds to produce the project and then leave it without paying those investors back. Remember that doing your own research is a necessary process before investing.

What is Crypto Staking?

Staking is another popular way to multiply crypto. It is like putting your crypto coins to work to earn money without selling them.

Think of it as a way to save your money in a special crypto account that gives you more interest than a regular bank. When you save money in a bank, they lend it to others, and you get a tiny part of the interest they make — not much. With staking, you lock up your crypto coins to help the crypto network run smoothly and stay secure. In return, you get rewards in the form of a percentage of your coins. These rewards are usually much better than what banks give you.

How Does Crypto Staking Work?

Crypto staking works by leveraging the proof-of-stake (PoS) or delegated proof-of-stake (DPoS) consensus mechanisms within blockchain networks. Instead of relying on energy-intensive mining (as seen in proof-of-work systems like Bitcoin), PoS and DPoS networks use the staking of cryptocurrency tokens to validate and secure transactions.

On Biswap DEX, examples of staking are Launchpools, Liquid Staking, and Fixed Staking. All of them are similar in their way of operating. To launch your passive income through staking you need to deposit a certain amount of cryptocurrency for a lock period. During this period, you will be gaining crypto rewards, whether in one or several other crypto, with no extra actions from your side.

Advantages of Crypto Staking

• Passive Income: staking offers a way to earn passive income by simply holding and locking up your crypto tokens without the need for active trading.
• Energy Efficiency: staking is more environmentally friendly compared to traditional mining, as it doesn’t require the energy-intensive computational processes of proof-of-work systems.
• Liquidity: some staking platforms allow for flexible withdrawal options, enabling users to access their staked tokens and rewards relatively quickly.
• Network Participation: staking actively engages users in the network’s security and consensus process, contributing to the decentralization and robustness of the blockchain.
• Governance Influence: many PoS networks allow token holders to participate in governance decisions, giving them a say in protocol upgrades and changes.
• Rewards Potential: staking rewards can be significantly higher than interest rates offered by traditional banks, providing an attractive opportunity for earning higher returns.

Essential Aspects to Consider of Staking

• Locking Periods: some staking systems have mandatory locking periods during which you can’t access your staked tokens. This lack of liquidity could be a disadvantage if you need immediate access to your funds.
• Market Volatility: the value of staked tokens can be affected by market fluctuations, impacting the overall returns earned from staking.
• Reward Variability: staking rewards may not always be consistent and can be influenced by factors such as network congestion and changes in the protocol.
• Impermanent Loss: while more common in liquidity provision (yield farming) scenarios, certain staking mechanisms could still expose participants to the risk of impermanent loss.

How do Yield Farming & Crypto Staking Differ?

Now, as we have gone through the concepts, principles of work and benefits of both yield farming and crypto staking it’s time to make a comparison.

How to Choose the Right Platform for Passive Income?

At the expense of the crypto market, there are thousands of DApps to choose from. It would be best to be cautious, as the more projects are established, the harder it is to select a trustworthy and worthy one. We’ve gathered a list of common red flags to help you analyze a project, detect its mistakes, and avoid tricky platforms.

🚩Weak Security Measures, No audit
Security is one of the highest priorities. That’s why Biswap always encourages its users to DYOR and care for their safety. Having a project undergo an audit is crucial for several reasons, as it contributes to its credibility, security, and overall success. For instance, Biswap is audited by CertiK, and you may review its code audit history, overall security score, community trust, and more.

🚩Lack of Whitepaper
The whitepaper has to be incredibly detailed to give users a clear idea of the plans, goals, and strategy for the long term. In contrast, scam projects would rather sidestep their token’s whitepaper or make it very general, as they want to save time. How to read a whitepaper? Click to review all the details here.

🚩Bad Tokenomics
Tokenomics is a fundamental aspect of each crypto project. If you notice suspicious allocation of tokens, burning mechanisms, vesting, and fees, avoiding the dark horse is better.

These are the main red flags to take into account, but we’re encouraging you to reveal all of the flags to be fully prepared for the research

Summing Up

Yield farming and crypto staking are prominent methods for generating passive income within the cryptocurrency ecosystem. Yield farming offers the allure of high rewards but requires a deep understanding of protocols and complex strategies. Staking, in turn, provides more stable returns and is suitable for those valuing consistency and lower risk. In any case, both strategies contribute to the broader crypto ecosystem, yield farming by providing liquidity and staking by securing networks.

FAQs Section

What types of tokens are eligible for staking and yield farming?
Different blockchain networks and platforms support staking and yield farming for various cryptocurrencies. Commonly, these involve tokens that use proof-of-stake (PoS) or delegated proof-of-stake (DPoS) mechanisms.

How can I choose the right yield farming protocols?
Research is key. Look into the protocol’s security, team, audits, and rewards structure. Diversification and risk management are also important.

What is impermanent loss in yield farming?
Impermanent loss occurs when the value of assets in a liquidity pool changes, resulting in reduced returns compared to simply holding the assets.

Is there any difference in earning via yield farming on V2 and V3 AMM protocols?
Yes, on AMM V2, users can’t manage their liquidity and choose how to provide it. Also, on this protocol, users get LP tokens and need to make additional steps such as staking them into farms. AMM V3 protocol is more efficient, allowing users to choose a fee tier, make several liquidity positions, and concentrate liquidity on a specific price range.

What’s the difference between APR and APY?
APR represents the interest rate you would pay on a loan or earn on an investment without considering the effects of compounding. APY considers the effects of compounding, which means that it considers how often the interest is added to the principal amount over the year.