Today we have so many ways to earn more tokens: mining, staking, yield farming, easy savings and many more. As the years pass by, blockchain developers find new ways of providing passive income opportunities where users can use existing capital to gain more crypto assets.
In this article we will try to answer questions every new defi degen has. What are the risks of yield farming? Are higher APY rates enough for the community to ignore all the safety hazards that unsecured liquidity pools offer? What is the difference between staking and yield farming?
What is staking?
Staking is a mechanism derived from the Proof of Stake consensus model, an alternative to the energy-fueled Proof-of-Work model where users mine cryptocurrencies. Rather than spending electricity and hardware power to solve complex mathematical problems and confirm transactions, stakers lock up their assets to act as nodes and confirm blocks. So how does staking produce rewards?
Typically, in order to earn staking rewards you’d have to become a node validator for a PoS blockchain, where you’ll get token rewards for securing the network. However, today you can stake not only on blockchains, but on protocols and platforms. Many projects offer their users to stake their assets without having to deal with the technicalities of setting up a node. The exchange in question will handle the validating part of the process on its own, while the staker’s only job is to provide the assets.
This way, the user can stake multiple assets just from one place. Moreover, he will not have to suffer the effects of slashing, a mechanism that cuts down a user’s assets whenever he acts maliciously. To summarize, the main goal of staking is to secure a blockchain network by improving its safety. The more users stake, the more decentralized the blockchain is, and hence, it is harder to attack.
What is savings?
Savings or yield farming, alternatively known as liquidity mining, is a method of earning cryptocurrencies by temporarily lending crypto assets to DeFi platforms in a permissionless environment. For example, Mover offers multiple savings options.
Each of those options, work by the same principles: borrowers post cryptocurrency as collateral to borrow and are required to post more value as collateral than they are allowed to borrow. This over-collateralization mitigates the risks to lenders because even if borrowers never make a repayment their collateral can be sold to repay the depositors. This economy creates rewards (or interest) for lenders. Mover optimizes the performance of user funds by finding the highest paying vault and controls the depositing and withdrawal strategy.
Decentralized lending protocols are the main product of the DeFi market, and in order to facilitate trades, they rely on user’s capital (borrowers and lenders). When a yield farmer (or a service like Mover) provides liquidity to a dApp, they earn a portion of the platform’s fees, which are paid for by the users of that platform. Yield farmers contribute their assets for as long as they want. Remaining in the non-custodial and permissionless space, capital owners decide what to use, and how long to provide their capital for.
As a result of their high yield rates (APY), yield farming pools are highly competitive. Rates change all the time, which forces liquidity farmers to switch back and forth between platforms. The downside to this is that the farmer pays gas fees every time he leaves or enters a liquidity pool. During times of high network congestion on the Ethereum network, hunting for high-APY LPs is almost completely inefficient. That is why solutions like Mover optimize the deposits across multiple networks in automated yield farming strategies.
Savings vs staking
Savings might be the most profitable option for passive investments. It is also less risky, as Mover savings are denominated in USDC. Staking, on the other side, can provide better returns if actively monitored.
Security-wise, staking on newer projects might result in a complete loss as developers can create so-called “rug pull” projects. After listing a new token and allowing users to deposit funds into liquidity pools, the project’s creator will shut down the project and disappear with the funds.
Even if the developer acts in good faith and works on a serious project, they might end up unintentionally creating a hole in a smart contract’s code that makes it possible for a hacker to exploit it. This is common in projects that feature both flash loans and yield farming. Once an LP is drained, the assets are forever gone, and there is no central entity that can return them.
One of the possible drawbacks in staking, could be the time lock requirements. A staker might be forced to lock their assets for the duration of an entire year, or even longer, depending on the project. For example, Ethereum 2 staking doesn’t currently have any withdraw features. During that time, the depositors cannot move or sell their assets.