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What is DeFi staking?


DeFi, or Decentralized Finance, refers to financial services that are – decentralized. That is, DeFi aims to bypass traditional financial channels and middlemen, such as banks, and uses blockchain technology to make financial services available to everyone, everywhere. Here, we’ll cover DeFi staking, which is a popular way to earn passive income with tokens.

DeFi staking explained – Definition & Example

DeFi staking allows you to earn a passive income simply by holding a certain amount of eligible cryptocurrencies on DeFi platforms. The two most popular ways to earn income with DeFi are staking and yield farming.

DeFi staking explained – Definition & Example

In DeFi staking, participants add their tokens to a staking pool, and an algorithm chooses which miner (or node) validates the block and earns the rewards. Even though the node is chosen at random, users who have more tokens at stake have higher chances of being picked by the algorithm.

In DeFi staking, participants add their tokens to a staking pool

Staking has become extremely popular in recent times. Solana, for example, has more than $40 billion of staked coins that earn an average APY of 5.88%, at the time of writing. It’s less resource-intensive than validating transactions with the Proof-of-Work mechanism, and users are able to earn an attractive reward for staking their coins. The reward – expressed as Annual Percentage Yield (APY) – is often higher than depositing funds in a traditional savings account.

Yield farming, on the other hand, involves lending your coins on a decentralized exchange. Here, you’re not acting as a validator on the blockchain, but as a liquidity provider to the exchange.

Decentralized exchanges offer many incentives to attract users to their platforms, one of which is quite high APYs. In fact, yield farming is more profitable than staking, most of the time. It’s also currently one of the most powerful drivers of the DeFi sector.

Types of DeFi staking

There are several different types of DeFi staking that generate passive income to investors. Staking is just one of them, with the other two (yield farming and liquidity mining) becoming increasingly popular.

How does DeFi staking work? 

Earning interest with DeFi staking requires depositing eligible tokens into a DeFi protocol. Not all cryptocurrencies allow DeFi staking, such as Bitcoin for example. Bitcoin, the largest cryptocurrency in the world, uses Proof-of-Work which doesn’t support staking. Other cryptocurrencies that do support DeFi staking, such as Ethereum, often have a minimum deposit requirement to become a validator on the network. Currently, the ETH2 platform requires a minimum of 32 ETH to become a “staker”, although this can be bypassed with the help of staking pools, which will be explained later.

So, when you stake your tokens on the network, those tokens are utilized to verify transactions on the blockchain (using the Proof-of-Stake mechanism). They act like collateral and a guarantee that a block of transactions is error-free. 

The interest that you earn on your tokens is a reward for lending your tokens to the network in order to verify transactions. The node that gets chosen by the algorithm to verify a block earns the reward, and the new tokens are returned to the original investor. Besides minimum deposit requirements for some networks, certain platforms also have a minimum holding period during which you can’t withdraw your tokens. This holding period is also called the locking or “vesting” period.

How does yield farming work?

Just like staking, yield farming allows you to earn interest on your crypto holdings. The main difference to staking is in the way how your coins are utilized by the platform. Yield farming involves lending your cryptocurrencies to liquidity pools on DeFi platforms, which are essentially smart contracts for holding your coins. Decentralized exchanges (DEXs), such as Uniswap or Curve, depend heavily on liquidity providers. Since DEXs provide a decentralized way to exchange different cryptocurrencies, they don’t act as middlemen between buyers and sellers. Instead, they use liquidity pools that act as automated market makers (AMMs) and offer the automated exchange of coins.

If you lend your cryptocurrencies to a liquidity pool, you’ll earn interest. Each time traders exchange one coin for another on a DEX, they pay a fee, which is then redistributed to the different liquidity providers in proportion to how much liquidity they provide to the DEX.

What are the pros and cons of DeFi staking?

DeFi staking provides several advantages to investors. Besides the possibility of earning passive income, DeFi staking also comes with lower entry barriers and is usually highly secure. Here are the main advantages to start staking today.

DeFi staking also comes with lower entry barriers and is usually highly secure

Pros:

Cons:

What are the pros and cons of yield farming?

Just like staking, yield farming comes with a set of advantages and disadvantages. Let’s see whether yield farming has more pros than staking.

Pros:

Cons:

What are the models of DeFi staking platforms

Decentralized Finance staking is a fairly new concept, and staking mechanisms often differ from one platform to another. Today, there are usually three main models of DeFi staking, which are explored in more detail in the following lines.

Important aspects of DeFi staking platforms

DeFi has emerged as just another buzzword in the crypto ecosystem, but the concept has gained a lot of traction in the industry. Choosing the right DeFi platform isn’t an easy choice, so here are some points that may help you in making your decision.

Graphical user interface

There is a growing number of DeFi platforms on the internet. To attract users, some of them try to build attractive and simple user interfaces, although this isn’t always an easy task given the underlying complexity of DeFi and staking. When choosing a DeFi staking platform, make sure that its user interface is simple enough and intuitive. Dealing with private keys, staking tokens, adding to liquidity pools, and withdrawals of accrued interest have to be simple and effortless.

List of supported assets and their protection

As its name suggests, DeFi is decentralized and unregulated. This means, if you lose your funds for any reason, there is no authority that will refund your loss. Fortunately, most DeFi staking platforms follow high standards of security, and the underlying blockchain technology makes it very hard for hackers to crack the system and steal funds. You could also create a smart contract on the network to make sure an agreement gets executed automatically once the contract’s conditions are met.

Rewards calculator

Investors who stake or lend their coins on a DeFi platform are doing so with one main goal: earn interest and make a profit. That’s why a rewards calculator would be a very useful tool that you can use to calculate your prospective earnings on a DeFi network.

Rewards calculator

Some DeFi platforms have an integrated rewards calculator on their website. There are many factors that influence how much you’ll receive from staking your coins, including the share of coins in the network, the volatility of the coins, and the time duration for which you’re locking your coins on the platform.

Payouts

Besides the profit that can be made with DeFi staking, users are also interested in the payout schedule and withdrawal procedures for specific networks. Before choosing a DeFi platform, make sure that the payout schedule fits your expectations and that your preferred withdrawal option is offered.

Conclusion

Decentralized Finance (DeFi) is a new and exciting way to earn passive income on your eligible cryptocurrencies. The popularity of DeFi staking is best described by the value of coins currently staked on various networks – dozens of billions of USD have already been invested in DeFi as of 2022. To recap, there are two main ways to use DeFi to earn passive income: staking and yield farming. DeFi staking refers to staking your tokens to a Proof-of-Stake network, which are then used to verify and validate new transactions on the blockchain. Yield farming involves lending your coins to decentralized exchanges and providing liquidity.

In general, the more coins you have invested, the more you can earn on your coins. To improve competitiveness, smaller investors often pool their tokens into pools where any rewards are distributed based on the share of tokens each investor added to the pool.

Making a passive income with DeFi doesn’t come risk-free. Price volatility of cryptocurrencies, slashing events, and rug pulls can all have a negative impact on your potential profits. Advantages include passive income with attractive Annual Performance Yields (APYs) that are significantly higher than what traditional financial institutions would offer.

In addition, choosing the right platform for DeFi staking and yield farming can be overwhelming to beginners in the field. If you want to earn interest on your coins without having to worry about PoS, staking pools, liquidity pools, and different DEXs, take a look at PrimeXBT’s Yield Accounts. Simply pick a coin and start earning today.

FAQ: Frequently Asked Questions

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