Crypto 101: Understanding Yield Farming vs. Staking

by Jake Wengroff

Yield farming and staking are two DeFi investing strategies gaining in popularity. Though not necessarily for the crypto beginner, they are worth investigating regardless of current investing focus, as they are helping to drive the proliferation of DeFi protocols, making crypto more widely available and useful in a range of applications.

Let’s have a look.

What Is Yield Farming?

Yield farming enables an investor to plan and choose which tokens to lend, and on which platform, in order to garner the highest returns. Thanks to DeFi lending protocols, cryptocurrency holders have the option to lend their funds and get rewarded. Investors’ funds are aggregated into liquidity pools. 

An attractive strategy, yield farming produces passive income for yield farmers, as they are paid according to the interest rate paid by the borrower, or the users of the liquidity pool.

In the traditional banking system, financial operations such as lending and borrowing are handled by banks, which act as intermediaries. While banks use “order books,” yield farming uses smart contracts or automated market makers (AMM) to facilitate crypto trading.

Yield farming, also known as token farming, launched in 2020 with Compound, the first DeFi lending protocol. Crypto asset holders place their funds on one of two types of platforms: a lending platform such as Compound or Aave, or on a decentralized exchange (DEX), such as Uniswap or PancakeSwap.

Yield farming is considered essential to the growth and maturity of the crypto and DeFi markets. Because of the investors serving as liquidity providers, providing their funds for liquidity pools, other users are able to lend, borrow and trade crypto. All crypto transactions have a service fee, which is distributed among the liquidity providers. 

As an additional incentive to drive adoption of new crypto assets, all lending protocols have a native token distributed to the liquidity providers to further incentivize liquidity pool funding.

What Is Staking? 

An explanation of staking requires some fundamentals about blockchain transactions. Proof-of-Work (PoW) and Proof-of-Stake (PoS) are two consensus mechanisms used to validate transactions on a blockchain platform.

Proof-of-Work vs Proof-of-Stake

Bitcoin, the first blockchain ever created, uses PoW. This consensus, often called mining, uses hardware to provide node validation and generate new blocks on the blockchain. Since computers need to perform these complicated calculations, they tend to cost more, due to high electricity usage. As a result, mining is not a sustainable system, and not everyone can be a miner on the network.

PoS, however, is an alternative to the PoW. Instead of mining, and far less energy-consuming, validators stake their crypto using complex algorithms to generate new blocks. New platforms prefer staking over mining, as it is much more eco-friendly. 

How to Stake Crypto

Ethereum, the most popular network for DeFi, has begun to upgrade its network to a PoS mechanism to offer sufficient transaction throughput. 

Users are required to stake either a fixed amount to become validators, or they can participate in liquidity or staking pools. Each staking platform may have slightly different rules; the most common way is using staking pools. Indeed, by participating in the pool, a “regular” crypto investor can stake, without needing to individually and personally validate transactions using the PoS protocol on the blockchain.

Usually staking involves locking your crypto funds, which of course means that crypto assets need to be acquired beforehand. 

Staking accomplishes two benefits: securing the network and earning passive income. As with yield farming, each liquidity pool has different conditions, such as a fixed time frame and annual percentage yields, or the predicted annual income for participation in that pool. 

Yield Farming and Staking with Greater Peace of Mind

While staking to validate transactions on the blockchain will not create vulnerabilities — the blockchain cannot be hacked — those who stake do get rewarded with crypto, and that crypto needs to eventually be stored in a wallet or the wallet feature on an exchange. 

Wallets and exchanges, no matter how secure, are still vulnerable to attack. Once a private key is stolen, it can be very difficult for the rightful owner of the assets to demonstrate proof of ownership. Yield farming takes place on platforms and decentralized exchanges that can also be vulnerable to compromise.

The industry needs solutions that can keep up with the evolving marketplace of wallets, exchanges and platforms, in order to protect all participants. TransitNet is creating the industry’s first third-party title registry that demonstrates proof of ownership of crypto assets, to add a layer of protection for investors, borrowers and others involved in yield farming and staking.

Join the forefront of the new crypto infrastructure. 

Request an exclusive registration for TransitNet’s title registry when it launches today.

Jake Wengroff writes about technology and financial services. A former technology reporter for CBS Radio, he covers such topics as security, mobility, e-commerce and IoT.


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