As a newbie coming into the world of DeFi, you always hear the saying, "the farmer will make more money?" In most cases, you seem not to understand the meaning. It is hard to get the idea from a crypto perspective, as we think it is literal farming on a farm.
In DeFi, one can farm and stake just as in the real world. So, what are yield farming and staking in Decentralized Finance (DeFi)?
What is Real Yield Farming?
At a basic level, yield farming means lending crypto assets to DeFi platforms to earn fixed, variable interest. As such, yield farming means earning rewards by depositing crypto into a pool with other users.
DEXs are the backbone of the DeFi market, and to facilitate trades, they rely on investors willing to provide liquidity in exchange for a portion of the platform's fees. It also involves locking up your funds in a liquidity pool, which are smart contract containing funds.
Besides, the farmers can loan their assets for as long as a year or as short as they want and earn fees daily. The math is simple; the more one lends, the higher the rewards.
The idea may not be so far along from staking in DeFi. So, what exactly is staking?
Staking in DeFi
Crypto staking involves locking up a portion of your crypto for a while to contribute to a blockchain network. In exchange, stakers can earn rewards, typically in the form of additional coins or tokens.
Derived from the Proof of Stake (PoS) consensus mechanism, staking is an energy-efficient alternative to Proof-of-Work (PoW) consensus. A solution to the energy-intensive PoW, where users need computational power to solve complex mathematical problems, stakers act as nodes. As such, they stake their crypto and confirm blocks.
In PoS, users must set up a node and join any PoS network to become validators. However, centralized and DEXs offer staking to their users without worrying about the technicalities of setting up a node.
Additionally, users provide their crypto assets, and the platform or exchange takes care of the validating process. Therefore, it allows users to stake multiple assets. In short, staking aims not to create liquidity but to secure a blockchain network. Consequently, more stakers make the blockchain decentralized and secure against attacks.
Benefits of Yield Farming
Yield farming leads to increased liquidity
Lower platform fees
Ability to earn interest on your assets
You can earn while you rest.
You have higher returns than traditional finance.
Yield Farming Risks
Liquidation Risk- The possibility of zero balance. Liquidation risk happens when your collateral's price drops beyond your loan's price.
Smart Contract Risk- Yield farming is controlled by smart contracts that remove the intermediaries in traditional finance. Smart contract risk is high as malicious hackers can explore code bugs.
Gas Fees- Increased gas fees are one of the risks associated with yield farming.
Final Thoughts
Investors can earn far greater rewards through yield farming than through traditional investments. However, with higher rewards come higher risks.
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