With the evolution of the crypto world, the variety of products and services has greatly expanded and the possibilities of obtaining income from investments have therefore increased, even of obtaining remuneration for the mere fact of owning cryptocurrencies. This is staking and yeld farming.
Staking and Proof of Stake (PoS)
To understand what staking is, it is necessary to clarify what is the Proof of Stake (PoS), the concept of staking in fact originates from the PoS algorithm.
PoS allows blockchains to operate with greater energy efficiency while maintaining a good degree of decentralization compared to the Proof of Work (PoW) option. The core idea of PoS is that participants can lock some cryptocurrency (their “stake”). Periodically, the protocol will randomly assign one of them the right to validate the next block. The amount of cryptocurrency the user locks will determine the probability: the higher the value, the higher the probability. Producing blocks through PoS allows, not only significant energy savings, but also a greater degree of scalability for blockchains. For this reason, Ethereum‘s network began its migration from PoW to PoS in December 2020 via various technical updates known collectively as ETH 2.0.
Staking is generally about holding funds in a cryptocurrency wallet to support the security and operations of a blockchain network. In a nutshell, staking consists of locking cryptocurrencies in order to receive rewards.
In most cases, you can stake your coins directly from your crypto wallet. Many exchanges also offer staking services to their users. For example, Binance allows to earn rewards just by keeping cryptocurrencies on the exchange. However, there may be constraints that depend on the platform. For example, the requirement of a minimum balance for staking, lock the stake for a fixed period and, usually, a withdrawal period defined by the protocol.
Staking rewards also vary depending on the platform. They range from systems that offer constant percentage fees to others that apply algorithms that consider various factors such as the volume of funds staked by the user, how long the user has been staking, how much is the total volume of funds staked on the platform, etc.
Multiple staking users can then come together in staking pools to increase their own weight and increase their gains. For example, by increasing the likelihood to become the next block validator. Staking pools are also particularly useful on platforms that have entry barriers. Each individual investor would not reach the barrier on their own. With the centralisation of staking at the exchange platforms and services specifically created for this purpose, a new phase opens for this profitable instrument. It is no longer strictly necessary to hold one’s cryptocurrencies in one’s own wallet, which makes the system easier to use. However, it is important to rely on platforms that offer high security guarantees against cyber attacks.
Yield farming, or liquidity mining, is another way to make money using cryptocurrency funds. Like staking, it involves locking cryptocurrencies to receive rewards. On a general level, yield farming is similar to staking. However, it is much more complex.
Typically it involves users called liquidity providers (LPs), who add funds to liquidity pools on a platform. Users can borrow this liquidity from the platform. A liquidity pool is nothing more than a smart contract that contains funds. In exchange for the liquidity provided to the pool, LPs receive a reward, which can be made up of fees generated by the underlying DeFi platform or from other sources. Some liquidity pools distribute rewards in different tokens, which can be deposited in other liquidity pools to earn money from there as well, and so on. Those involved in yeld farming typically develop complex strategies aimed at maximising investment returns. The strategy may operate moving funds between platforms as opportunities arise. However, the basic idea is that a liquidity provider deposits funds into a liquidity pool and receives rewards in return.
Yield farming is closely tied to a model called automated market maker (AMM). It typically involves liquidity providers (LPs) and liquidity pools. Using these platforms involves fees, which are then distributed to liquidity providers based on their share of the liquidity pool. This is the basic structure of how an AMM works, then each platform has its own specific features. As an example of a platform where one can do cryptocurrency yeld farming we can mention Curve Finance. It is an automated market maker for exchanges between stablecoins. It is a decentralized liquidity aggregator where anyone can add assets to different liquidity pools and then earn fees. Other platforms in the AMM space are Compound Finance, MakerDAO, Aave, Uniswap.
The development of blockchain applications in DeFi is increasing the opportunities to realise revenue. This can happen by just owning cryptocurrencies or from using sophisticated strategies to optimise the placement of one’s crypto assets. Technological developments and the interconnection between different blockchain platforms will create more opportunities in future.