What are the differences between Staking, Liquidity Mining & Yield Farming?
Staking, liquidity mining, and yield farming are all words that are frequently misunderstood.
While each of these words indicates that a user is compensated for making their assets available for a limited time in order to perform an economic purpose, their underlying natures differ.
Because it is utilized in numerous reward model types that no longer correspond to the historical definition in Crypto, the term “staking” raises a lot of concerns.
Staking, liquidity mining, and yield farming all have one thing in common: users are compensated financially for supporting something.
The entities that actually pay out the incentive are the first semantic distinction between these phrases.
In addition to the benefits already offered by a DEX, a Staking Reward Program may payout awards to users for supplying liquidity to DEX pools. A firm wanting to secure its future would be the entity in this case.
The entity’s incentive for handing out the rewards/earnings is the second component that renders these terms non-interchangeable. In each situation, you are providing value to the reward payer, which is something you should be aware of. This could be increasing network security for a protocol, maintaining the foundation of its business model (user-provided liquidity), or giving needed funds for a startup with its own incentive scheme.
What is Yield Farming?
Yield farming is a broad phrase that encompasses a variety of practices. It refers to the act of “locking” your own liquidity for a set amount of time in exchange for a variable payment (based on the size of your stake). In DeFi yield farming can be done in a variety of ways. Lending and providing liquidity on decentralized exchanges like Uniswap are the most frequent.
What is Liquidity Mining (or Liquidity Staking)?
“liquidity mining” and “yield farming” are interchanged. Liquidity mining, in actuality, is really a subclass (child) of yield farming.
Decentralized exchanges (DEPAY/DAI, for example) are made up of pools of multiple currencies. It is in the DEX’s and its users’ best interests for trades to run properly. This implies that someone interested in purchasing an asset should be able to meet with a seller.
Similarly, sellers should always be able to find eager buyers, allowing for continuous high-volume trading. Furthermore, with automated market makers like Uniswap, substantial price swings might occur during deal execution.
Slippage can be high when an initial deal is large in comparison to the overall pool liquidity. This means that at execution time, the predicted (original spot) price can vary dramatically to the trader’s disadvantage. The impact of huge trades can only be mitigated if a pool has enough liquidity.
DEXs like Uniswap incentivize their users for filling pools with liquidity and working as so-called “Liquidity Providers” (LPs) to ensure that traders’ demands are constantly met.
Your contribution as an LP gives you a proportional share of the fees paid by buyers and sellers on each trade, based on the entire liquidity pool. Liquidity staking is another term for “liquidity mining.” However, the phrase “staking” has a significant risk of being misunderstood. The next sections explain why this is the case.
What is Staking?
- “I will vote as a stakeholder,” for example, meaning that your investment may grant you specific rights, such as those relating to governance.
- “I have a stake in/of” could refer to a financial stake in something.
- “I’d put my car down on it.” = In this example, “stake” refers to a risk you’re willing to take because you believe in something. You’re gambling if your conviction isn’t founded on research and evidence. This gets us to the game of poker:
- Your stake (or buy-in) in poker refers to the amount of money you’re willing to risk in a given session.
- “My job is on the line” suggests that if you fail at something, you will lose your job. It signifies a high level of danger.
- “I staked the young team of researchers with a new microscope” signifies that you (financially) support someone’s work toward a goal.
- To grow safely, young trees “need a stake.” To stabilize and support the growth of newly planted trees, stakes are used. So, what’s in it for you? Most likely, some delicious fruits!
We can see that the following features are frequently mentioned:
- Increased rights and influence are possible outcomes.
- Possibility of profit as a risk compensation
- Increasing security: providing financial or other resources to promote growth or the achievement of goals.
Before the DeFi boom, the term “staking” meant that as a staking participant, you (the “staker”) took on the role of a validator in a network in the context of a “proof-of-stake” (POS) method to strengthen network security.
Even today, depending on the underlying technology, this process can take on a variety of forms and typically necessitates a high level of technical knowledge. The more users who engage in proof-of-stake consensus by confirming transactions and adding new blocks in a POS-based system, the more efficiently and securely the network runs. The purpose of rewarding you for doing so is to ensure the present and future of the technology you’re pursuing. In POS Staking, you make some of your assets available to the network in exchange for a specified quantity of reward coins for the value you create (network security).
Technical skills (such as server administration/docker/programming languages to establish up so-called “nodes”) are not the only barrier to entry in POS Staking. A minimum amount of asset or even infrastructure investment is frequently required, which not every regular crypto user wants or can afford.
What is Staking in DeFi?
Without a POS mechanism, the term “staking” is often used today, notably in DeFi.
In these instances, Liquidity Staking is frequently confused with Liquidity Mining. However, as stated in the opening to this page, when the term “staking” is used, the entities and their motivations for giving out staking payments are not always the same.
However, if you’re trying to earn passively in the crypto sector for the first time by “staking,” we recommend doing some study first to figure out what “value” you’re creating with your money. It’s a good idea to know what risks are involved and whether the corresponding benefit is justified (for example, “permanent loss” when locking up assets for a long time).
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