Many users have difficulty understanding the difference between staking and yield farming. However, these two types of decentralized finance (DeFi) investments have numerous differences between them, and understanding these variations is vital to making good decisions as an investor on the Solana network.
Thus, in this article, you learn the difference between staking and yield farming on Solana through the following sections:
- What Is Solana?
- What Is Staking?
- Benefits and Risks of Staking
- What Is Yield Farming?
- Benefits and Risk of Yield Farming
- The Difference Between Staking and Yield Farming
Solana is a blockchain network that offers fast, secure, scalable, and decentralized transactions. It has its own native token called SOL.
The uniqueness and efficiency of the Solana network are possible due to a series of factors. The most relevant of those is its delegated Proof of Stake (PoS) method that powers the Solana blockchain. Solana also complements PoS with another mechanism called Proof-of-History (PoH), which helps validators to agree on the orderingordeing of transactions taking place on the network. These two combined with other factors made Solana the fastest blockchain network, with extremely low transactions fees and great scalability.
Staking is the process of actively participating in the maintenance and provision of infrastructure for the network to run on. It is comparable to mining, as a less resource-intensive alternative. Staking involves crypto investors depositing the respective blockchains’ native assets in a smart contract. Then, the individual who provided these funds to be available for the upkeep of the network receives a sort of remuneration for doing so. In fewer words, staking is the act of contributing to the security and maintenance of the underlying blockchain and being compensated for it.
To fully understand staking, you should first know about Proof-of-Stake. The basic notion is that users can lock tokens (their "stake") in order to be eligible for the right to write new transactions into the ledger, hence appending and validating the next block to a blockchain. The chances of being chosen are proportional to the number of tokens you have locked up, put differently, staked. This means that the more tokens you have locked up, the higher the likelihood of being picked to append and validate the next block. Now, in order to avoid a brutal ‘rich-get-richer’ scenario, randomness also plays a crucial role in the selection of validators. Picture a lottery drum. The more stake one has, the more tickets they are allowed to put into the drum. Tickets get drawn randomly at certain time intervals.
This is the basic notion of what staking is, however, if you wish to have a more detailed explanation of staking, you can access this article.
Staking presents numerous advantages to SOL holders. Here are the main ones:
Earn rewards. SOL token holders can earn rewards by staking to one or more validators in the network. The yield of staked assets on Solana is determined by the current inflation rate, the amount of SOL staked on the network, and the uptime and commission (fee) of each validator. Thus, SOL stakers can potentially earn extremely good returns.
Support the security of the Solana blockchain. By staking, you are helping to secure the Solana network. As explained, part of the gains of your staking goes towards validators that perform the actual footwork: running and maintaining the actual infrastructure.
Low fees. Thanks to its PoS mechanism, Solana is able to offer extremely low fees, especially if compared to PoW networks. Thus, the transaction fees you will pay to start staking on Solana are almost non-existent, leaving more funds towards the investment and potential returns.
The hazards connected with Proof-of-Stake protocols are also a hot topic in debates about staking vs. yield farming. Unsurprisingly, the risk is significantly reduced in the case of staking when compared to yield farming. It should be noted that the safety of the staked tokens is directly proportional to the safety of the protocol. Ultimately, staking can be considered one of the safest – if not the safest – DeFi investment.
At the same time, you should keep in mind that there are some significant risks associated with staking coins, such as slashing, volatility risks, validator risks, and downtime risks. Furthermore, you may have to deal with difficulties like fund loss or theft, reward waiting periods, project failure, liquidity hazards, minimum holdings, and long lock-up periods.
Still, by making your due diligence and getting to know the team behind the validators you picked, the chances of facing one of these dangers is very low.
You can learn more about staking on Solana and why it is important in this blog post.
Yield farming, in its simplest form, refers to any blockchain protocol that allows anybody with particular crypto token holdings to provide his/her tokens for liquidity purposes to a market maker and get rewards in exchange. These incentives, which are more akin to rewards, are frequently distributed as protocol governance tokens to yield farmers. To put yield farming another way, rather than keeping one's crypto assets in one's wallet, one may offer them to a service provider and receive interest.
A lending protocol, which provides a peer-to-peer lending/borrowing service, is a prime example of this. The crypto investor lends his crypto assets to a platform like a decentralized exchange which utilizes them in exchange for interest payments. Simply said, to yield-farm, a user may earn interest when they provide crypto assets to a decentralized finance (De-Fi) platform. Supplying liquidity to an Automated Market Maker (AMM) in return for liquidity incentives – tokens awarded to liquidity providers – is another common kind of yield farming. These efforts require cash to fund swaps and stimulate expansion; thus, all parties gain something from this dynamic.
To learn more about Yield Farming, how yield farming works and what a liquidity pool is, check this article that presents a very detailed definition.
Yield Farming has become popular mainly due to these three benefits:
High returns on investment. Many new projects provide prospects for yield farming, with benefits in the form of the project's native tokens. Many individuals want to be early farmers in the hopes that the tokens will rapidly grow in value, allowing them to exchange their gains and make a significant profit.
Low maintenance. Yield farming doesn’t demand much from the user, besides having a crypto wallet and placing an investment. This makes this investment option even more attractive for those that are looking for a passive and attractive income.
Low Fee. While yield farming on Ethereum carries the risk of extremely high transaction fees, the same cannot be said about projects on Solana. The Solana network offers extremely low transaction fees, which allows users to invest in yield farming without the risk of having to invest too much in fees. You practically only need the amount you wish to add to yield farming platforms to start investing.
Comprehension of staking vs. yield farming can only improve with a better understanding of the risks connected with each. It is critical to understand that high yield generation usually comes side by side with high-risk. It is a high-risk, high-reward investment dynamic. When it comes to yield farming, which does tend to offer higher potential returns than staking, impermanent loss, smart contract risk, composability risk, and liquidation risk are some of the risks to consider. To avoid them, it is important to do your due diligence by getting to know who the team behind the protocol of your choice is and if any respected developers are involved in it. A huge red flag is when the whole team of a project is anonymous. Make sure the project is transparent about the team, returns, and the overall operation before yield farming with it. Ideally, the smart contracts that the project utilizes are open source and have been audited.
Once the concepts of Yield Farming and Staking are understood, it becomes clearer how different both of these approaches are. While some investors have a hard time comprehending how they differ from each other, the table below demonstrates how completely distinct they are.
As seen, staking and yield farming are backed by different technologies, present different rewards, and are susceptible to different risks. Even though both offer rewards for locking your coins, the way they manage to offer these rewards is not at all the same.
It is possible to state that staking is a safer investment than yield farming. At the same time, yield farming can potentially offer higher returns than staking in exchange for this extra risk involved.
PoS blockchains introduced us to two excellent investing opportunities: staking and yield farming. While they have some similarities, they are quite different types of investments that provide consumers with more alternatives for preserving their currencies and tokens on the blockchain. They both have the potential to create lucrative passive income and are available on the Solana blockchain. Ultimately, the one you choose will be determined by your financial needs and ambitions. But this isn't a case of selecting one or the other. Diversifying your crypto portfolio is just as crucial as it is with your fiat bank. Investing in both can be a prudent decision since it optimizes risk management and returns.
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Please note that none of this is to be considered financial nor investment advice. We highly advise you to always do your own research (’DYOR’) before interacting with any of the projects or tools we write about. Crypto is a highly dynamic and fast paced environment with lots of moving parts that can quickly change.