What is Yield Farming in DeFi?

Yield farming is the process of deploying Decentralised Finance (DeFi) to maximize the user’s returns by depositing crypto assets into a pool with other users. With the DeFi platforms, users can borrow, lend and earn other crypto assets in return. Smart contracts are used to automatically facilitate crypto yield farming, requiring minimum human intervention while conducting transactions efficiently.

Yield farming involves a liquidity provider (LP) and a liquidity pool (which is a smart contract filled with tokens). Think of a liquidity provider as an investor who deposits tokens into a smart contract to fuel liquidity. Yield farming works on the automated market maker (AMM) model which eliminates the need for the conventional order book and instead creates liquidity pools using smart contracts.

Advantages of Yield farming

Yield farming allows investors to deposit money in a DeFi platform or protocol, just like a savings account where you deposit your money with a bank, and earn interest in return for the funds deposited. However, unlike the banking system, DeFi utilizes smart contracts where the deposited crypto is invested automatically and the user starts earning interest.

Investors can earn yields by investing their tokens in decentralized applications or dApps such as Decentralised Exchanges (DEXs) which are generally used to lend, borrow, or stake tokens.

What is Staking in DeFi?

Staking is usually of two kinds in the DeFi world. One is in the form of proof-of-stake blockchains in which the user provides their tokens for consensus and network validation. In the second form, the user stakes LP tokens that are earned while injecting liquidity into the DEXs. As a result, the users can earn yield twice, once for supplying liquidity in LP tokens which can then be staked further to earn more yield.

Advantages of Staking

Staking is considered to be a generally safe method for generating passive income in DeFi through validating crypto transactions. The initial investment requirement in staking is considered to be lower, making it accessible to a large number of investors.

The staking process also offers fixed interest rates that are beneficial in calculating returns at the time of depositing funds. Fixed returns are helpful for users who prefer a stable APY from their investments in order to predict their future returns.

Things to Keep in mind before participating in DeFi Staking vs Yield Farming

How Yield farming works

Yield farming begins with the process of creating a pool of crypto assets. The following steps are undertaken to facilitate DeFi yield farming:

• Liquidity pool: Creating a liquidity pool is the first step within yield farming. Investing and borrowing within specific yield farms are facilitated by the use of smart contacts.

• Depositing assets: Users can connect their digital asset wallet for depositing assets within the liquidity pool. Also called staking, this process is similar to users depositing in their bank accounts or investing in a mutual fund.

• Smart Contracts: Smart contracts, which are self-executed computer codes, allow several processes such as providing liquidity to a crypto exchange, lending, borrowing, etc.

• Rewards: Once you have entered the liquidity pool, you start earning rewards in the form of interests that vary by yield farm. The rewards could be paid at regular intervals or a later date in the future, depending on the terms agreed upon.

How Staking works

Staking is a process where the users lock their crypto assets to a blockchain network for a certain timeframe and earn staking rewards in return. By locking their crypto assets, stakers ensure securing a Proof-of-stake blockchain network.

Individual nodes are set up by the stakers who validate transactions and add new blocks to the blockchain. Staking is crucial as it helps secure the network from malicious actors. Validator nodes are randomly selected by the network and stakers with high-stake nodes have a greater chance of validating transactions and earning rewards. A percentage of the platform’s fee and the network tokens are earned by the users for adding each new block to the blockchain.

Is Yield Farming better than staking?

Staking is not as flexible as yield farming as the blockchain requires the users to lock up their funds for a stipulated time frame. If users require continuous access to their assets, staking is not the most appropriate option as the funds will be locked for a certain period. One can opt for short-term staking options but the APY offered is usually lower than yield farming.

With yield farming in DeFi, users stand a chance to earn high APY but also require higher initial investments. Investors also need high-risk tolerance and thorough due diligence before investing in a particular protocol or a liquidity pool. Several protocols offer higher returns but investors should carry out certain checks such as vulnerabilities in smart contracts, the track record of the protocol, and the developer team behind the project before investing.

DeFi wallets such as Okto make it easier for users to explore vetted investment opportunities and explore liquidity pools with higher APYs. One of the major hindrances within yield farming is the complexities involved with using various platforms to farm and make additional income on your crypto. However, Okto’s user interface is designed in a way that makes it easy for a novice user to explore varied opportunities across pools on a single app and invest securely.

In a nutshell, investors with a high-risk appetite and those who are seeking more flexibility with the lock-up period of their investments should opt for yield farming after conducting due diligence on the project. Staking is idle for those with a low-risk appetite, seeking easier returns on their idle crypto holdings, and who do not wish to get involved with the intricacies of liquidity pools.