Recently, the concept of decentralized finance has appeared. The goal is to provide a totally brand new system of finance without intermediaries. People can access a diversified list of services. Among them, the most common are staking and farming.
What are staking and farming?
Those two concepts emerged with the apparition of the cryptocurrencies.
Staking is a way to earn money by locking a quantity of a token, for a certain period of time. The people who stake tokens, the stakers, are rewarded with an amount of tokens. This amount depends on the APR (annual percentage rate, which can be more or less important depending on the platform we use.
Farming is another way to earn money but contrary to staking, we have to lock two different tokens. The tokens are then placed in liquidity pools. By providing the liquidity, the farmers will get a share of all the interests generated by the trades on the pool. The profits are far higher than with staking most of the time, but the risk is also bigger.
What are the benefits?
It is possible to get from 5 to 10% annually by staking stable coins such as Tether (USDT) or USDC. For other coins, it can be higher than 100%, but the risk is higher because the value of the coin could decrease over time as it is not stable.
The most famous platforms to stake are Aave and Compound. Another way to increase the profit is to increase the locking period. The longer we lock tokens, the higher the profit.
Farmers will get more benefits by locking a pair of tokens.
Generally, the yield is expressed with the APY (annual percentage yield), because the interests are compounded, which means that we can reinvest the benefits anytime. PancakeSwap or BakerySwap are two famous platforms to farm.
Image Credits: Aave.com
What are the risks?
Staking and farming are amazing sources of revenue but they include risks.
Indeed, when we lock tokens to stake them, depending on the period we choose, the market could be bearish and the value of tokens could fall quickly. If we are not able to unlock tokens directly, in order to sell them and cut off the losses, we could lose more.
Farming is even more risky than staking because a major problem we face is impermanent loss. By being exposed to a liquidity pool, when the price of the two tokens vary, we are subject to some losses. If the ratio between the two tokens evolves, when you withdraw the tokens, you will get less money than you had at the beginning. The loss is often negligible compared to the profits made with the interests, but in case of a huge move in the market, it could be important.
To conclude, staking and farming are two interesting concepts in decentralized finance. They represent a good revenue source and are more accessible to everyone. They are not without risk but the profits are considerable compared to traditional finance.
By Léonie Zaegel