On your journey through the DeFi metaverse, you are likely to come across terms like staking, yield farming, and liquidity mining. They all refer to a client putting their resources on the side of a blockchain, DEX (decentralized exchange), shared security options, or some other potential applications that demand capital.
Despite sharing a lot of similarities in terms of practical applications, there are a lot of aspects that are different from one another.
Staking: An Overview
Staking is the most comprehensive amongst staking vs yield farming vs liquidity pools. However, unlike yield farming and liquidity pools, it consists of numerous non-crypto definitions that can guide you about your stake assets in a crypto network.
Staking one’s reputation on something is a common phrase. This implies that you risk your integrity favouring a cause you believe in. A stakeholder is somebody who has an interest in a company or organization. This can include shareholders, employees, consumers, and anybody else who has a stake in the company’s success or failure.
Let us understand staking from the following aspects:
Staking is the act of putting up collateral as proof of a party’s stake in the game in the crypto world. The staker’s actions are in good faith if they have exhibited a financial interest in the protocol’s future success.
Staking can be used to support various encryption and DeFi protocols in various ways. A shift from Proof of Work (PoW) to a Proof of Stake (PoS) is in progress in the Ethereum 2.0 paradigm. Validators will need to stake parcels of 32ETH instead of giving hashing power to the network to verify transactions on the Ethereum network and get block rewards.
- Centralized platform support: Users can stake their digital assets on centralized platforms like Nexo, Coinbase, and BlockFi. These organizations are similar to commercial banks in that they accept consumer deposits and lend them out to people who need credit. Depositors receive a part of the interest paid by the creditors, and the bank keeps the remainder.
- Polkadot network: Polkadot’s, Nominated Proof of Stake (NPoS) consensus method allows DOT holders to stake their tokens and designate validator nodes in exchange for an annual percentage yield (APY). Other protocols demand users to stake tokens in order to participate in governance decisions and vote.
- Decentralized platform support: Other staking applications, such as PoS or centralized credit provision, work differently from CertiKShield’s model (a decentralized insurance alternative). It combines DeFi’s openness with the market’s most trusted security firm to create a whole new crypto industry: decentralized on-chain protection from losses and hacks. CTK stakers run the platform and get paid for the value they bring to the network. They can earn up to 30% APY by supplying liquidity to the collateral pool through CertiKShield. These tokens serve a vital economic purpose by underwriting the insurance policies taken out by other users who are willing to protect their assets in the case of a protocol attack or failure.
Need for Staking
The future stakers must reason considerably the need to stake before staking their assets. Some protocols require staking to prove a user’s stake in the game or enable critical financial activities, while others merely employ staking to reduce circulating supply to raise the price.
Yield Farming: An Overview
Yield Farming or YF is by far the most popular method of profiting from crypto assets. The investors can earn a passive income by storing their crypto in a liquidity pool. These liquidity pools are like centralized finance or the CeFi counterpart of your bank account. You deposit your funds that the bank utilizes to credit loans to others, paying you a fixed proportion of the interest gained.
Yield Farming is a more recent concept than staking, yet sharing a lot of similarities. While yield farming supplies liquidity to a DeFi protocol in exchange for yield, staking can refer to actions like locking up 32 ETH to become a validator node on the Ethereum 2.0 network. Farmers actively seek out the maximum yield on their investments, switching between pools to enhance their returns.
Consider the following aspects for a better understanding of yield farming:
- Crypto assets are stored into a smart contract-based liquidity pool like ETH/USD by investors known as yield farmers, and the practice is known as Yield Farming. The locked assets are then made available to other protocol users. These tokens can be borrowed for margin trading by users of the lending platform.
- Yield farmers serve as the cornerstone for DeFi protocols that provide exchange and lending services. They also help to keep crypto-assets liquid on decentralized exchanges (DEX). Yield farmers earn compensation in the form of an annual percentage yield (APY)
- Liquidity providers post two tokens — Token A and Token B, with Token B, typically being ETH or a stablecoin like USDC or DAI — in exchange for a share of the fees paid by users that use the pool to trade tokens.
- The pool percentage that a depositor makes up determines the depositor’s returns. If their deposit equals one per cent of the pool’s depth, they will receive one per cent of the pool’s total fees.
Risks with double-sided and single-sided liquidity pools
- Temporary loss is one of the prime concerns of yield farming in double-sided liquidity pools. Take, for example, an ETH/DAI pool; because DAI is a stablecoin, its value basis is the US dollar.
- However, the upward potential of ETH is limitless. As the value of ETH rises, the AMM adjusts the depositor’s assets’ ratio to ensure that their value remains constant.
- The disparity between the value and the number of tokens deposited is where the temporary loss can arise. The number of Ether equal to the first DAI deposit lowers as ETH appreciates.
- When the depositor withdraws their liquidity from the pool, this temporary loss becomes permanent. Therefore, if the temporary loss is more than the fees, a liquidity provider might better keep their tokens than depositing them to a pool.
- Single-sided deposits with temporary loss protection are available from AMMs like Bancor. However, other yield farming and interest-bearing products, such as CertiKShield, cannot produce temporary loss by design.
YF glow point
Yield farming may be very profitable, especially early on in a project when your deposit likely makes up a significant portion of the pool. However, due to cryptocurrency’s intrinsic volatility and the inventive design of new financial instruments, there may be associated risks that the yield farmers need to consider before ploughing the yield fields.
Liquidity mining is widely regarded as one of the most critical aspects of DeFi success and an effective mechanism for bootstrapping liquidity. Just as YF is a subset of staking, liquidity mining is a subset of YF. The primary difference is that liquidity providers are compensated with the platform’s own coin in addition to fee revenue.
Let us go through the following features for a better understanding of liquidity mining:
- The practice of receiving remuneration in the form of protocol’s native tokens by the users of a DeFi protocol in exchange for participating with the system is liquidity mining.
- It is the process of depositing or lending specific token assets with the goal of giving liquidity to the product’s fund pool while also earning money.
- A liquidity miner can earn incentives in the form of the project’s native token or, in some cases, the governance rights it represents. In most cases, tokens are generated based on the protocol’s programming.
- Even though most of them cannot be used outside of the DeFi platform that created them, the establishment of exchange markets and the excitement surrounding those tokens help drive up their value.
- Compound was the first to introduce liquidity mining when it began rewarding users with COMP, its governance token. This additional stream of income for liquidity providers can help cover some or all of the temporary loss risk they take on.
- Whereas COMP tokens flow not just to liquidity providers but also to debtors. For the first time ever, a borrower can receive a return on the loan they’re taking out thanks to liquidity mining incentives.
Liquidity mining requirement
- LPs (Liquidity mining programs) can often stake the tokens they earn in pools, thus earning a return on their initial investment and the incentives they receive.
- Liquidity mining for a DeFi platform has shown to be a successful method of attracting liquidity.
- Liquidity mining methods are often limited to a set number of months or years: just enough time to get the protocol up and running. While token incentives are frequently inflationary, diluting hodlers, they are frequently limited to a set number of months or years.
An Outline of Staking Vs. Yield Farming Vs. Liquidity Mining
In general, liquidity mining is a derivative of yield farming, which is a derivative of staking. All the solutions are just methods for putting idle crypto-assets to use. The main goal of staking is to keep the blockchain network secure; yield farming is to generate maximum yields, and liquidity mining is to supply liquidity to the DeFi protocols.
The APYs are frequently lucrative, and there are hundreds of different alternatives available. It is always a precautionary measure to inquire about the associated risks, the reason for the requirement of your tokens and the mechanism to generate returns.
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