Yield farming vs staking: how do they differ?
Yield farming is the placing of crypto-assets in DeFi protocols, such as liquidity pools, to earn fees and interest, and the moving of them to whichever protocol pays more. Staking is the locking of the native asset of a proof-of-stake blockchain so that a validator can earn block rewards. Both promise a return, and neither is a bank deposit.
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Yield farming and staking in brief
| Terms | Yield farming, also called liquidity mining, with the same meaning. Staking. German: Yield Farming, Staking. |
|---|---|
| A number | Crypto lending, borrowing and staking "account for more than 50% of all total value locked (TVL)" in DeFi (EBA and ESMA, ). |
| EU law | Regulation (EU) 2023/1114 (MiCA), applicable since , has no article on either activity. Recital 94 leaves the lending and borrowing of crypto-assets out. |
| Supervisors | BaFin in Germany, FMA in Austria, FINMA in Switzerland. |
What is yield farming in crypto and DeFi?
Yield farming in crypto is the search for the highest return across DeFi protocols. A saver in classic finance moves a deposit to the bank that pays more interest; a yield farmer moves crypto-assets between lending pools and exchanges on the blockchain. The EBA and ESMA describe 'yield farming' or 'liquidity mining' protocols as services that let users earn yield "by using algorithms to automate the transfer of crypto-assets from one protocol to another to maximize yield". The report gives one definition for both terms.
The report links part of the demand to the interest rate cycle: the 'low-for-long' environment "may have pushed retail investors to 'search for yield' by depositing crypto to obtain interest in DeFi". Leveraged yield farming adds debt. The report lists 'leveraged farming' protocols in which users "undertake yield farming with borrowed crypto-assets".
How does yield farming work with a liquidity pool?
Yield farming works mostly through liquidity pools, the pools of crypto-assets that a decentralized exchange uses in place of an order book. Liquidity providers deposit two crypto-assets in the pool "and receive a share in the liquidity pool in return" (ESMA, ). Traders swap one asset for the other at a rate that a smart contract sets by formula. The providers earn the trading fees.
The pool brings its own risk: impermanent loss, also called divergence loss. ESMA defines it as "the loss in value of the reserves in the pool compared to holding the reserves outside of the pool". A study by Loesch and others, cited by ESMA, looked at pools that held 43% of the value locked in Uniswap V3 in 2021. In certain pools 70 to 75% of the providers lost more from impermanent loss than they earned in fees. So yield farming vs liquidity pool is a question of level: the pool is the tool, and yield farming is the strategy that moves money from pool to pool.
How does staking differ from yield farming?
Staking differs from yield farming in who pays: in staking the blockchain pays for validation work, in yield farming other users pay for liquidity. The EBA and ESMA define staking as "the process of immobilizing crypto-assets to support the operations of PoS and PoS-like blockchain consensus mechanisms in exchange for the granting of validator privileges that can generate block rewards". Validators, rewards and slashing are explained on the page What is staking?
Many platforms also call other yield offers "staking". The joint report names them "DeFi staking" or "stacking" and states that they are not linked to proof of stake and involve no validators. Depending on their terms, they can be "comparable to a savings account or to crypto lending".
What is the difference between yield farming and staking?
The difference lies in the source of the return and in the risks the holder carries.
| Feature | Yield farming | Staking |
|---|---|---|
| Who pays | Traders and borrowers who use the pools | The blockchain, as block rewards |
| Assets | Many crypto-assets on various blockchains, often in pairs | Only the native token of a proof-of-stake chain |
| Who does the work | Smart contracts; an algorithm or the farmer moves the assets | Validators that propose blocks and vote on them |
| Typical risks | Impermanent loss, exploits of smart contracts | Slashing, and a lock-up and unbonding period "of several (tens of) days" |
| Leverage | Leveraged farming with borrowed crypto-assets | Higher leverage risk "where lending services are used to fund staking" |
Quotes: joint report of the EBA and ESMA.
Staking vs lending: where does crypto lending fit?
Crypto lending works like a secured loan: the lender hands crypto-assets to a borrower or a pool and earns interest, and the borrower posts collateral. Every form of crypto lending that the EBA and ESMA studied asks for more collateral than the loan is worth and sells the collateral when a threshold is hit.
In DeFi the line between lending and yield farming is thin. Depositors in a lending pool earn interest, and "in doing so, lenders become liquidity providers in DeFi", as the report puts it. The report also warns that overcollateralized lending, combined with procyclicality in DeFi, "may lead to rehypothecation, ultimately leading to collateral chains".
Yield farming and staking in Germany, Austria and Switzerland
In Germany and Austria MiCA applies directly. BaFin is the competent authority in Germany under section 3 of the Kryptomärkteaufsichtsgesetz (KMAG). In Austria the FMA holds that role under the MiCA-Verordnung-Vollzugsgesetz. Recital 22 of MiCA sets the limit for DeFi: where crypto-asset services "are provided in a fully decentralised manner without any intermediary, they should not fall within the scope of this Regulation". Recital 94 adds that MiCA "should not address the lending and borrowing of crypto-assets".
A bank or asset manager that holds a client's crypto-assets or private keys for either activity provides custody under Article 3(1)(17) of MiCA. It needs an authorization under MiCA or, as a credit institution, a notification under Article 60(1), sent at least 40 working days before the start.
Switzerland is outside the EU, so MiCA does not apply there. FINMA supervises banks and securities firms and set out its view of staking services in Guidance 08/2023. This page gives no legal advice.
Sources
- European Banking Authority and European Securities and Markets Authority: Joint Report: Recent developments in crypto-assets (Article 142 of MiCAR),
- European Securities and Markets Authority: Decentralised Finance in the EU: Developments and risks,
- European Union: Regulation (EU) 2023/1114 on markets in crypto-assets,
- Federal Republic of Germany: Kryptomärkteaufsichtsgesetz (KMAG),
- FMA: FMA takes over supervision of crypto-asset service providers in Austria,
- FINMA: FINMA publishes guidance on staking services, with Guidance 08/2023,