Blockchain has acted as a boon for the digital economy through the introduction of cryptocurrencies. It has opened numerous avenues for investors who have been looking for a one-to-one platform for earning income without the involvement of intermediaries that charge huge amounts of fees to facilitate basic transactions. Decentralized finance has emerged as a perfect solution to this problem. It is a financial technology with secure ledgers backing it. Speaking of decentralized finance, you may have heard of terms like yield farming, liquidity mining, and staking. While these terms may seem to have a similar meaning, they are not the same. Let’s understand each of these terms and see how they work in DeFi protocols.
What is Yield Farming?
Yield farming involves lending your cryptocurrencies or tokens to get rewards in the form of transaction fees or interests. It is an investment strategy where people can earn income by lending their assets to the farming pools. It is the most important factor that is driving the growth of the decentralized finance sector and has helped in increasing the market cap from $500 million to $10 billion within a matter of one year.
How does Yield Farming Work?
The yield farmers lend their tokens to the liquidity pools which are basically decentralized applications having smart contracts. When the participants lock their tokens in the pool, they get a fee from the decentralized finance platform supporting the liquidity pool. The liquidity pools in turn support marketplaces where people borrow or lend money and pay a fee for the services. This fee helps in rewarding the liquidity providers or yield farmers for lending their tokens.
What is Liquidity Mining?
Liquidity mining is the process of lending tokens to a fund pool in order to provide liquidity. The liquidity miners get rewards in return for their tokens depending upon their share in the total liquidity pool. These rewards are provided in the form of the native tokens of the protocol to the liquidity miners for cooperating with the protocol.
How does Liquidity Mining Work?
The participants place their assets in the liquidity pools which are generally available on decentralized finance protocols. The provided assets improve the liquidity of the pools and facilitate more transactions in the liquidity pools. In turn, the liquidity miners can earn many benefits like rewards, high yields, governance tokens, native tokens, and so on.
What Does Staking Mean in Crypto?
Staking means locking your cryptocurrencies in a staking pool to receive rewards. It is the process of committing the cryptocurrencies to support a blockchain and earning rewards in return. The transactions in staking have Proof of Stake as their consensus mechanism . It is the protocol by which the participants obtain the right to validate the next block in the blockchain by locking their coins. The protocol choses the participant in the order of their staked amount of coins. This means that the more coins you lock, the more is the probability of the protocol choosing you to decide the next block of the blockchain.
How Does Staking Work?
The staking process starts with validators or coin holders who lock their coins in the staking pool. The Proof of Stake protocol randomly selects the validators at specific intervals of time. The chosen validators then create a block for the blockchain. In order to be chosen by the protocol, the validators must stake large amounts of coins. In return, the validators are supposed to maintain the network security of the blockchain. If the network security is compromised, the entire stake held by the validators can be at risk.
What is a Staking Pool?
A staking pool is the group where validators come together with their resources and participate in the pool to maximize their chances of validating the new blocks and earning rewards in return. When they receive rewards, they are proportionally shared among the validators based on their initial contributions.
Yield farming, liquidity mining, and staking may look alike as all of them involve the lending of assets. However, they differ from each other in terms of their underlying technologies, the rewards, and the risks associated with them. So, here is a glance at the differences between yield farming, liquidity mining, and staking.
Yield farming, liquidity mining, and staking are very effective ways of earning passive income from your existing crypto assets like cryptocurrencies, tokens, NFTs, etc. The rewards earned from these decentralized processes are very attractive, which can then be used to earn another round of income. For example, in the case of liquidity mining, you can earn rewards like NFTs which you can rent, sell, yield-farm, or stake to earn another round of passive income. However, there are various risks associated with each of these DeFi processes. Therefore, investors are advised to set clear objectives and ways to achieve those objectives right in front of them to avoid losing money.