A DeFi Guide to Staking, Yield Farming and Liquidity Mining

发布于 Apr 14, 2022 | 部落格

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What is Staking?
Staking ETH VS Stablecoins and Other Altcoins
Liquid Staking
Risks of Staking
What is Liquidity Mining?
What is Yield Farming?
Risks of Liquidity Mining and Yield Farming
Staking ETH with CYBAVO

The ascent of decentralized finance (DeFi) protocols since the summer of DeFi in 2020 has revolutionized the face of the crypto industry and scared the world of traditional finance (TradFi), who are now slowly joining the party. Smart contract-powered DeFi applications offer users the chance to earn significant interest and yield on investments multiple times bigger than what traditional banks and financial institutions can offer. 

Scanning liquidity and staking pools on DeFi protocols and exchanges might make even the most disciplined investor look twice at the crazy Annual Percentage Yields (APY) on offer. However, these enticing options may come with traps, which we cover in this article. DeFi staking is predominantly a young man’s game, where the biggest gains require great technical competence, a healthy risk appetite, long hours of researching on social media and websites, and a constant monitoring of assets. However, if you simply want to earn a steady annual interest rate of 5-20%, simple staking might be the answer, and often requires nothing more than a simple click or two from your crypto wallet. Let’s dig deeper. 

What is Staking?

Staking enables cryptocurrency holders to earn passive income from their assets by providing liquidity and depositing them in protocols that support a proof-of-stake (PoS) consensus mechanism, where transactions are verified by validators instead of miners, as is the case in proof-of-work (PoW). 

Unlike miners, stakers don’t need expensive mining rigs to participate in maintaining the network. And while they are free to decide how much they want to stake, their rewards are usually proportional to the amount they deposit in a protocol or staking pool.

Staking ETH VS Stablecoins and Other Altcoins

ETH has been one of the most sought-after tokens for staking since its Beacon Chain upgrade introduced proof-of-stake (PoS) on Ethereum in December 2020. Its market dominance is greatly due to being one of the longest-standing layer-1 blockchains in the space with proven security measures.

In order to stake on Ethereum directly, you need at least 32 ETH and a decent computer server that can stay online 24/7. If you don’t have the budget or the means, there are several staking operators that enable you to stake less than 32 ETH without the hassle of setting up a validator node. However, these operators will take around 10% of your profits.

As secure and reputable as Ethereum is, staking in the protocol is currently a one-way trip, which poses some risk for investors. If you’re more risk averse, then staking stablecoins like USDC might be more to your liking, as you won’t have to worry much about volatility either. Note that stablecoins typically produce less yield, for the most part ranging from 5-8% APY.

Higher risk also entails higher rewards, so if you want to be on the edge, then perhaps you should consider staking smaller PoS altcoins like SOL, ADA, BNB, or AVAX. Note that these chains are less decentralized than Ethereum and may be more volatile in price, and with most of these networks, you normally have to delegate to a validator.

Liquid Staking

Liquid staking is another form of staking where people get to utilize a tokenized version of their staked assets. These staked assets can then be used for all sorts of decentralized finance (DeFi) activities, especially in yield farming. Liquid staking allows users to retain their liquidity while staking, enabling them to earn passive income from staked assets while maintaining access to them.

For example, Lido Protocol allows users to gain exposure to Ethereum staking by simply holding stETH, a tokenized version of ETH staking that continually accrues rewards. Other platforms that enable liquid staking include Marinade Finance and Anchor Protocol, the latter offering up to 19.5% interest a year on staked stablecoins.

Risks of Staking

While staking is lucrative when done right, it also comes with many inherent risks. Therefore it is vital to weigh the pros and cons of how, what and where you stake. Self-custodial staking can be tricky and comes with many caveats. Here is a list of the risks involved with staking.

Slashing

Slashing happens when a validator fails to meet the security and integrity requirements of a blockchain, whether intentional or not. This can happen when nodes maliciously collude with other nodes to authorize a fraudulent transaction or when a validator misconfigures his system parameters. If you or your delegated validator gets slashed, you will lose a portion of your stake.

Volatility

Market volatility can be detrimental for stakers if a staked asset’s price swings to the downside, especially with ETH where the lockup period makes it impossible to sell in such circumstances. This can be avoided by staking stablecoins or via liquid staking.

Loss of Stablecoin Peg

This risk is only inherent in stablecoins, especially algorithmic ones like UST and DAI that are backed by other cryptocurrencies instead of real-world assets like fiat. If their price drops below their pegged value, such as if DAI drops below $1, this can cause the asset’s value to rapidly decrease. While minor fluctuations can easily be balanced out by arbitrageurs, black swan events could trigger a possible death spiral that could plunge the price to zero. 

High Pool and Gas Fees

Staking protocols, both liquid and illiquid, can offer different staking fees. Be on the lookout for validators or staking pool operators that charge exorbitant fees as these could affect your potential earnings. Conversely, using certain chains like Ethereum to stake crypto could rack up a decent sum in gas fees. 

What is Liquidity Mining?

Liquidity mining is a process where users deposit their asset pairs in a liquidity pool, providing liquidity for decentralized exchange (DEX) traders in return for getting proportional liquidity provider (LP) rewards in the form of native tokens, which can then be re-staked to the same protocol to compound the rewards. 

For instance, an LP can deposit equal amounts of UST and USDC in the UST-USDC pool on Saber and earn SUNNY tokens. If you want a more volatile token, then you might be better off with equal-value asset pairs like WETH-ETH or SOL-mSOL pools. 

Stablecoins and equal-value asset pairs eliminate the risk of impermanent loss (IL), but their rewards are also less. If you want to earn more LP tokens, you’ll have to venture into pools with higher risks, e.g., the CRV-DAI pool on Curve. Do note that this opens you up to impermanent loss or even rug pulls and hacks if you interact with insecure smart contracts. 

What is Yield Farming?

Yield farming is a strategy where users deposit their holdings to DeFi platforms to provide liquidity, but instead of getting native token rewards, they earn interest based on the reward percentage allotted for their pool. Your deposited liquidity will be utilized to give out crypto loans to others while you earn a portion of the interest.

Some of the biggest yield farming platforms include Uniswap, Sushiswap, and other automated market makers (AMMs). 

DeFi yields can be amplified when combined with staking and liquidity mining. For instance, you can take out a loan on Aave, use the funds to conduct liquid staking by buying stETH and ETH, and then use them to yield farm on Curve. 

Risks of Liquidity Mining and Yield Farming

Since liquidity mining and yield farming have a somewhat similar requirement, which is to deposit token pairs, they also have similar risks.

Impermanent Loss

Market volatility is a huge factor in impermanent loss, which happens when the price of your assets change in comparison to when you initially deposited them into a liquidity pool. The larger the change, the more you lose. Technically though, IL is considered unrealized loss since the value won’t drop below what you’ve originally invested.

It is crucial to consider the LP rewards or APR/APY before engaging in liquidity mining or yield farming, respectively.

Protocol Exploits

Many DeFi protocols have been targeted by attackers ever since the industry rose to prominence, with countless cases of hackers draining liquidity pools. Before doing any on-chain activity, you need to perform proper due diligence first, such as checking if a protocol has undergone rigorous security audits. The more platforms involved, the higher the probability of losing funds, which is why yield farming is usually riskier than liquidity mining.

For instance, yield farming on SushiSwap will probably involve Yearn Vaults, Aave lending pools, etc. If any of its integrated protocols are exploited, its funds also become vulnerable.

Rug Pulls

Rug pulls are one of the most common types of scams in DeFi, where the developers of a project decide to drain their liquidity pool and run away with their investors’ money, leaving them with the issued tokens that subsequently become worthless. Some founders take measures to lower the risk of investment for their users by locking up their treasury or creating a time-lock for withdrawal of funds, etc. However, the best way to avoid rug pulls completely is still to stay away from protocols with anonymous founders/developers. 

Loss of Stablecoin Peg

Similar to staking, yield farmers and LPs are also vulnerable to a loss of peg when dealing with stablecoins. When this happens, a pool would typically end up with the asset that lost its peg while its pair gets drained. For instance, if DAI goes to zero, then all DAI pools would have their pairs drained from the pools fast, leaving only the worthless DAI tokens.

Staking ETH with CYBAVO

If you’re looking to stake ETH, CYBAVO provides a secure and transparent way to for ETH 2.0 staking, as well as these unique benefits:

Maintenance-free: We remove the need for complex, expensive and tedious node maintenance, doing the heavy lifting for you.

Superior protection: We will help you avoid the confiscation of your principal investment due to improper node maintenance.

Enhanced private key security: If you lose or expose your private key, you may lose all your assets. Eliminate this risk by securing your staking private key with CYBAVO.

Learn more about CYBAVO ETH 2.0 staking