They are often considered the same because each refers to activities that rely on decentralized finance (DeFi), even though they both have different mechanisms. Understand these terms and how they work by reading this article to the end.
There are quite a lot of ways to get passive income in the cryptocurrency sector, and the most frequently used investment choices are staking or yield farming.
What is Staking?
In simple terms, staking is the process of actively participating in supporting a blockchain network to validate transactions by locking crypto assets into a wallet or network.
It's similar to mining, only users who stake only need to lock up a number of assets they own to get rewards, this is called a Proof of Stake (PoS) consensus, which is a proof of ownership mechanism.
Assets placed by users will be stored to help maintain and maintain the system network for a certain period of time. During this process, users will get interest as a reward in the form of staked coins.
This concept is what makes crypto staking used by many people to gain passive income, because apart from not having to carry out mining activities, the risk of staking is quite small when compared to yield farming.
How Staking Works
The Proof of Stake (PoW) mechanism is the best alternative solution to PoW. Through this method, validators only need to deposit their crypto assets (staking) into the network to create new blocks.
Investors who become staking validators do not need to understand the technicalities of setting up the code like miners do on the Proof of Work (PoW) blockchain. This is an advantage of the Proof of Stake mechanism because it is considered more environmentally friendly and does not require large computing power or special warfare to validate a new block.
What is Yield Farming?
Yield farming is a method of saving cryptocurrency by lending it to other parties to get rewards.
This concept is similar to deposits at banks in general, where the bank will provide interest for customers who save.
However, in the decentralized finance (DeFi) ecosystem, this method was developed so that it can run with smart contracts and without intermediaries such as banks who have full control over user funds.
Simply put, investors lend their crypto assets to be locked in a liquidity pool so that these assets can be used by DeFi protocols to facilitate trading or lending.
However, the profits from yield farming come from the amount of interest paid by the borrower or those using the liquidity pool.
How Yield Farming Works
Yield Farming is a method that only exists in the DeFi ecosystem and uses smart contracts of the Automated Market Maker (AMM) type to facilitate crypto trading in it. This activity involves Liquidity Providers (LP) as borrowers or users who save and Liquidity Pools which are containers or markets where users lend their assets.
Usually, Liquidity Providers get returns from certain fees or costs charged to market users or Liquidity Pools. However, each DeFi protocol has different rules and workflows in distributing fund turnover in its liquidity pool.
In short, the Liquidity Provider offers its funds to be put into a set of liquidity pools called Liquidity Pools. Later, users of the pool facility can borrow or trade crypto assets.
But besides all that, usually DeFi protocols that act like banks also have native tokens that are distributed as incentives to lenders.
It is important for investors to know the risks and do research first before choosing staking or yield farming on a protocol.
Always consider before making an investment decision, because basically both methods are a pattern of locking your assets for a certain period of time to get rewards.