Cryptocurrency staking and yield farming are two popular ways for crypto investors to earn passive income—generate income without actively trading. However, these two strategies operate differently, with distinct mechanisms, rewards, and risks.

The key to deciding the best strategy is understanding what staking and yield farming are, how they work, and how they differ.

What Is Cryptocurrency Staking?

Cryptocurrency staking involves locking up crypto on a proof of stake (PoS) blockchain in a designated cryptocurrency wallet to participate in the protocol's consensus mechanism. The basis of locking up crypto assets is to guarantee you're acting in good faith. Because you can lose your assets if you violate the protocol's rules, you're more likely to verify and add only legitimate transactions and data to the blockchain.

While staking is primarily a way to secure a blockchain network and verify its transactions, investors who stake earn rewards. For instance, you can stake or lock up your ETH on the Ethereum blockchain to partake in its PoS consensus process and earn ETH rewards.

How Does Cryptocurrency Staking Work?

Unlike proof of work (PoW) blockchains, which require miners and nodes, PoS blockchains require validators to verify transactions and secure the network without a central authority.

The more crypto you stake, the higher your chance of being selected to validate and add new blocks to the blockchain. As a validator, you earn a specified percentage of the fees for each transaction you validate. Depending on how you stake, you may also earn other rewards, including newly minted coins, interests, and voting rights.

Here's how you can stake your tokens:

1. You may stake the required minimum or more to maintain and run hardware or software that stores data, processes transactions, and adds new blocks to the blockchain. You'll earn the most rewards but do the most work here because validator nodes require 100% uptime.
2. Another way to stake is to create validator credentials, deposit the required crypto tokens or more, and delegate the validation process to a service provider running a validator node.
3. Suppose you don't have the minimum required stake for running a validator node or prefer not to run a validator node. In that case, you can use staking services offered by centralized and decentralized exchanges or join a staking pool.

You might have to pay a fee for delegated staking, joining a staking pool, or using centralized exchanges. Nevertheless, you'll earn rewards without actively trading.

Some more features of cryptocurrency staking include the following:

• There's usually a minimum amount of crypto you have to stake.
• There might be a locking period during which your staked tokens can't be withdrawn or transferred. However, several staking pools and centralized exchanges offer more flexible staking options.
• A slashing mechanism may be in place to enforce penalties for malicious behavior.

Examples of Proof of Stake Blockchains

Staking is the bedrock of PoS blockchains, and here are two key examples.

• Ethereum: Since Ethereum transitioned from a PoW to a PoS consensus mechanism, it now requires users to stake ETH. To run a validator node, you must deposit 32 ETH, but you can stake much smaller amounts of ETH on staking pools and cryptocurrency exchanges. Beaconcha records the estimated average annual financial return per validator over 24 hours was as high as 24% in 2022.
• Solana: This PoS blockchain protocol allows you to run a validator, delegate your stake to validator nodes, and join staking pools without requiring a minimum amount of SOL. Exchanges, including Kraken and Soladex, allow you to stake SOL without running a validator node.

Staking is often seen as a way to earn passive income, but its results can be mixed.

Yield Farming Explained

Yield farming involves lending crypto assets to decentralized finance (DeFi) protocols to generate rewards. The goal is to maximize your cryptocurrency holdings by providing liquidity or depositing the tokens into DeFi protocols. These tokens are used to facilitate crypto swaps or lent to borrowers who pay interest.

How Yield Farming Works

Instead of letting your crypto assets stay idle, you can deposit them into a decentralized exchange (DEX) as a liquidity provider (LP). You'll deposit your crypto assets into a liquidity pool to earn a percent of the DEX's generated trading fees and, sometimes, the DEX's governance token.

Alternatively, you can become a lender on a DeFi protocol. When people borrow from you, you'll receive a portion of the interest they pay—yield—and sometimes, the DEX's governance token.

When you decide to add funds to a liquidity pool, you'll need to connect your cryptocurrency wallet and initiate a smart contract to hold the funds for exchanging and lending and monitor your rewards. This smart contract will issue you a token, which you'll use to collect your rewards and redeem your crypto assets.

After "harvesting" rewards from providing liquidity or lending your assets, you can reinvest them into the DeFi protocols to earn more yields—this is called compounding. Your earnings will be measured using the Annual Percentage Rate (APR) or the Annual Percentage Yield (APY).

There are more complicated processes you can employ to earn more yields, like leveraging and DeFi looping, but they typically involve more risks. Nevertheless, as a yield farmer, you'll have to move your assets around, switch platforms, change strategies, and swap assets because the rewards constantly fluctuate based on the liquidity pool's trading volume.

Examples of Yield Farming

Only decentralized exchanges offer yield farming. Here are two popular yield farming platforms:

• Compound: This decentralized exchange allows the lending and borrowing of various crypto assets. As a lender on Compound, you'll earn interest depending on the coin you're depositing (lesser-known coins typically have higher interest rates). Compound also issues COMP, its governance token, to investors who provide liquidity or their crypto assets for crypto lending.
• Aave: This DEX lets you deposit your crypto assets for crypto lending and earn interest. You can also supply liquidity and earn rewards along with the governance token of the market in which you give liquidity.

Aside from these two, several DEXs allow you to provide liquidity or lend your crypto assets.

Staking vs. Yield Farming: What's the Best Option?

You can earn passive income from crypto staking or yield farming. However, each strategy has pros and cons that you should consider.

These pros and cons can be addressed in three crucial areas.

1. Complexity

While solo staking—running a validator node—is complex and intensive, only a few investors tow this path. The other staking methods are generally simpler than yield farming, especially as you only have to stake one token on one blockchain protocol.

Yield farming typically involves more tokens, protocols, transactions, and strategies, making pulling off more challenging and expensive.

2. Rewards

Since staking is more predictable than yield farming, you'll likely earn less than farming your assets. Staking earning rates are based on the underlying PoS network's parameters.

Meanwhile, yield farming has more dynamic interest rates and incentives dependent on the supply and demand of the underlying protocols. A liquidity pool with massive demand and supply may yield higher interest rates and incentives.

3. Risks

There's a lower chance of losing your crypto assets with staking than yield farming.

You'll incur a loss if there's a bear run while your assets are staked, and if they're locked in, you won't be able to do anything. You might incur penalties if your underlying validator node misbehaves or doesn't maintain 100% uptime. If you use staking pools or crypto exchanges to stake, there's no guarantee you'll receive staking rewards.

Meanwhile, yield farming exposes you to more market fluctuations across several assets. You may also encounter smart contract vulnerabilities or bugs and lose your deposited tokens and earned rewards. Moreover, earned trading fees are sometimes canceled out by impermanent loss, where there are imbalances in the liquidity pool and the price of one token tanks.

Ultimately, choosing between staking and yield farming depends on your preferences, risk appetite, and available resources. If you'd prefer a simpler, more stable, and less risky strategy, you'd be better off staking your assets. If you're more active, prefer more profits, and can deal with more risks and complexities, you can go for yield farming.

Alternatively, you can combine these two strategies to diversify your portfolio and earn the most passive income possible.

Always Research Before Staking or Farming Your Crypto

While staking and yield farming involve supplying liquidity to blockchain protocols to earn rewards, they have diverse purposes, mechanisms, risks, and returns. Understanding the two strategies will help you select the best one for your needs.

You can also employ both strategies. Just remember only to invest what you can afford to lose!