Yield Farming and Staking: Everything you need to know

Experts suggest that yield farming involves locking up cryptocurrencies in smart contracts to earn rewards

Yield Farming and Staking: Everything you need to know

By Gaurav Arora

Decentralized finance (DeFi) has emerged as one of the fastest-growing sectors in the crypto industry, enabling investors to earn passive income through innovative financial products and services. Two popular options for earning passive income in the DeFi space are yield farming and staking.

Yield farming involves locking up cryptocurrencies in smart contracts to earn rewards in the form of interest or fees on decentralized lending and borrowing platforms. The reward rates can vary depending on market demand and supply, making yield farming a potentially high-reward but risky option.

Staking, on the other hand, involves holding cryptocurrencies in a blockchain network and contributing to its security and transaction processing. In return, investors receive rewards in the form of newly minted tokens or transaction fees.

What is Yield farming?
Yield farming also known as liquidity mining, is a process where crypto asset holders lend or provide liquidity to decentralized finance (DeFi) protocols in exchange for rewards. These rewards are usually in the form of additional tokens or crypto assets that are issued by the protocol.

Yield farming allows investors to deposit money in a DeFi platform or protocol, just like a savings account where you deposit your money with a bank and earn interest in return for the funds deposited. However, unlike the banking system, DeFi utilizes smart contracts where the deposited crypto is invested automatically and the user starts earning interest.

What is De-fi Staking?

In the DeFi space, staking usually comes in two categories. One is in the form of blockchains with proof-of-stake, where users contribute their crypto assets for network consensus and validation. in the second form, the user stakes liquidity pool (LP) tokens that are earned while injecting liquidity into the DEXs. As a result, the users can earn yield twice, once for supplying liquidity in LP tokens which can then be staked further to earn more yield.

Staking is thought to be a generally secure way to earn passive revenue in DeFi by validating crypto transactions. The initial investment requirement in staking is lower, making it accessible to many investors. Fixed interest rates are another perk of the staking process that helps investors calculate profits when they deposit money.

How Yield farming works

Yield farming begins with the process of creating a pool of crypto assets. The following steps are undertaken to facilitate DeFi yield farming:

  • Liquidity pool: Creating a liquidity pool is the first step within yield farming. Investing and borrowing within specific yield farms are facilitated using smart contacts.
  • Depositing assets: Users can connect their digital asset wallet for depositing assets within the liquidity pool. Also called staking, this process is like users depositing in their bank accounts or investing in a mutual fund.
  • Smart Contracts: Smart contracts, which are self-executed computer codes, allow several processes such as providing liquidity to a crypto exchange, lending, borrowing, etc.
  • Rewards: Once you have entered the liquidity pool, you start earning rewards in the form of interests that vary by yield farm. The rewards could be paid at regular intervals or a later date in the future, depending on the terms agreed upon.

How Staking works

Staking involves holding cryptos in a blockchain network and contributing to its security and transaction processing.

Here are the steps to understand how staking works:

  • Users lock their crypto assets to a blockchain network for a certain timeframe.
  • Stakers set up individual nodes to validate transactions and add new blocks to the blockchain.
  • Staking ensures the security of a Proof-of-stake blockchain network and helps to protect it from malicious actors.
  • Validator nodes are randomly selected by the network, and stakers with high-stake nodes have a greater chance of validating transactions and earning rewards.
  • Users earn a percentage of the platform’s fee and network tokens for adding each new block to the blockchain.

It is important to note that DeFi staking, and yield farming involves risks such as smart contract and market volatility. Therefore, it is essential to conduct proper research and understand the risks involved before engaging in Yield Framing and DeFi staking.

The author is SVP, DeFi initiatives, CoinDCX

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First published on: 08-03-2023 at 13:15 IST
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