DeFi Staking vs Yield Farming: Knowing the Difference

Josiah Nang-Bayi, MD
10 Min Read

Decentralized finance (DeFi) offers novel ways for cryptocurrency holders to put their assets to work and earn yields. Two of the most popular methods are staking and yield farming. But what exactly is the difference between these two DeFi yield-generating strategies?

In this in-depth guide, we’ll explore staking and yield farming to understand the key distinctions as well as when each strategy shines brightest.

Defining Staking

Staking refers to actively participating in transaction validation on a proof-of-stake (PoS) blockchain network. It involves “locking up” a certain amount of your cryptocurrency holdings to become a validator on the network.

Validators are chosen to create blocks, verify transactions and maintain the integrity of the blockchain. In exchange for providing their crypto as stake and performing validation duties, staking participants earn staking rewards in the form of new token emissions.

Staking enables everyday cryptocurrency holders to act as validators rather than relying solely on specialized miners like in Bitcoin’s proof-of-work. Staking opens up participation while helping secure PoS networks.

Leading staking cryptocurrencies include Ethereum, Solana, Cardano, Polkadot, Tezos and Cosmos. The assets staked work as “skin in the game” that aligns incentives for validation with actual stake holdings to avoid malicious actions. The size of your stake controls your chances of being chosen as the next validator.

Defining Yield Farming

Yield farming, also called liquidity mining, involves locking up your crypto assets in return for rewards generated by a DeFi protocol. This allows you to put your tokens to productive use and earn much higher yields than traditional savings.

In yield farming, users typically provide liquidity to a decentralized exchange liquidity pool or a lending protocol fund pool to earn trading fees, interest, or governance tokens as rewards. Providing liquidity and generating high yields incentivizes users to stash their assets in the protocol.

Yield farming enables new governance token distributions, boosts liquidity for the protocol, and grows ecosystem activity and revenue. Popular yield farming protocols include Uniswap, Compound, Aave, Curve Finance and Balancer.

Now that we’ve defined both concepts, let’s analyze some of the key differences between staking and yield farming.

Consensus vs. Utility

The core purpose of staking is participating in consensus mechanisms and governing the blockchain, while yield farming aims to provide liquidity and utility to DeFi protocols.

For proof-of-stake networks, staking allows everyday users to secure the network and validate transactions through decentralized participation. It’s critical for maintaining blockchain consensus.

Yield farming, on the other hand, grants token rewards to users who provide capital to liquidity pools that power DeFi protocols. It incentivizes decentralized participation that creates inherent utility and revenue for the protocol.

One focuses on core consensus, the other on capital utility.

Roles and Requirements

Staking requires users to run infrastructure like nodes and maintain voting power to actively validate blocks and transactions on a PoS blockchain. Users must meet minimum staking amounts and technical requirements.

Yield farming simply involves depositing funds into smart contracts powering protocols. No special roles or infrastructure needs to be maintained – users passively earn rewards based on funds deposited into pools supporting protocol activity.

Staking carries more operational duties compared to yield farming’s plug-and-play model.

How Rewards are Earned  

Staking rewards are granted in the form of newly minted tokens from inflation or transaction fees collected by the protocol. The actual reward mechanisms depend on the blockchain, but ultimately rely on issuance of native tokens.

Yield farming rewards are usually provided in the native governance token of the protocol. Rewards are funded by a percentage of transaction fees generated on the platform. Some platforms also inflate rewards through token emissions.

Staking mint rewards, yield farming distributes fee/inflation rewards.

Risk Profiles

Staking requires validators to meet uptime requirements and involves slashing penalties if malicious activity is committed on the network using your staked capital. The stakes are higher.

Yield farming doesn’t penalize users for downtime. The only major risk is impermanent loss which can be managed through defensive strategies. The risks of reduced rewards are lower compared to staking.

Staking carries additional technology and uptime risks that are avoidable in yield farming.

Lockup Periods

Staking requires mandatory lockup periods in many protocols that can range from weeks to months or even years. Your staked crypto remains bonded during this time.

Yield farming offers more flexibility, with no minimum lockup periods in most protocols. You can withdraw liquidity at any point without waiting. Shorter lockups provide more maneuverability.

Staking demands long-term commitment, yield farming allows nimble adjustments.

Token Eligibility

Only native protocol tokens can be staked in pure PoS networks, limiting eligibility. For example, you can only stake SOL on Solana or ADA on Cardano. Trying to stake tokens across chains is not possible.

Various crypto tokens, stablecoins and tokenized assets can supplied to liquidity pools for yield farming. There are fewer token eligibility limitations compared to staking.

Staking is restricted, yield farming is more open.

When to Choose Staking vs Yield Farming

Based on the differences we’ve explored, here are some guidelines on when staking or yield farming may be the superior strategy:

– If you hold governance tokens in a PoS blockchain network, staking them supports decentralization and earns native rewards. Staking is a no brainer for HODLers.

– For major PoS networks like Ethereum after the Merge, staking will offer lower risk versus yield farming new applications.

– If you want to support emerging PoS blockchains long term, staking reinforces your vested interest in their success.

– For pure crypto exposure and maximizing governance power in protocols you support, staking is preferable.

– When market volatility is expected to be high, yield farming’s flexibility eases managing risks versus being locked into staking.

– If you have a short investment timeframe or want ability to pivot strategies, yield farming’s liquidity suits active management.

– For fixed or stablecoin holdings, yield farming will generate higher yields than PoS staking in most market conditions.

– To diversify across tokens and platforms for risk management, yield farming offers more options and composability.

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Weighing the Pros and Cons

Staking

Pros:

– Secures PoS networks through consensus

– Earns native token rewards

– Grants voting rights and governance influence

– Prominent strategy for long-term token holders

– Lower risk compared to unproven new protocols

Cons:

– Mandatory lockup periods restrict maneuverability

– Relatively low yields unless large validator

– Higher technology barriers to operate nodes

– Vulnerable to slashing penalties and uptime rules

Yield Farming

Pros:

– Compounds yields through varied liquidity strategies

– Earn rewards from rising projects early on

– Flexibility to move funds across platforms 

– Often higher yield potential than staking

– Accessible to wider range of crypto holders

Cons:

– Impermanent loss requires active management

– Rewards dependent on continuous protocol revenue

– Governance power more diluted compared to staking

– Requires more research and platform evaluations

– Higher risk of losses from new protocol flaws

Conclusion

Staking and yield farming offer complementary ways to put your crypto to work. Staking is ideal for securing blockchain networks you believe in for the long haul. Yield farming optimizes yield across assets and protocols with more fluidity.

While their core purposes differ, both staking and yield farming empower decentralized participation and alignment of incentives. For crypto holders looking to maximize rewards, a blended portfolio incorporating staking, yield farming and direct holdings may offer the ideal balance of risk and yield.

The DeFi movement opens up powerful new possibilities for earning yield while supporting protocols you align with. But understanding the nuances between staking and farming enables crafting smarter strategies optimized for your portfolio and risk tolerance.

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Josiah Nang-Bayi, MD is a medical doctor by profession, an author, a financial literacy and digital assets enthusiast, an entrepreneur and a growing philanthropist.
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