Staking vs. Liquidity Providing: Which one is better?

by Nov 27, 2022Defi, Hot Stories0 comments

Staking and liquidity provisioning is the simplest and most successful ways to earn money with your cryptocurrencies, with many users now earning a passive income from these activities. But, are they secure? Is one superior to the other? What are their advantages and disadvantages?

This article will explain staking and liquidity provisioning in detail and provide practical examples.

What does liquidity provide?

The process of adding value to a liquidity pool is known as liquidity provisioning. Liquidity pools are groups of digital funds that are locked in a smart contract. Anyone can contribute liquidity to a pool and become an LP (liquidity provider). This is made feasible by AMM (automated market-making), which functions in a manner similar to ordering books in centralized markets.

What exactly is staking?

Staking is a method of putting your coin or tokens to work without selling them. Staking is similar to putting money in a savings account. When you deposit money into a savings account, you intend to leave it there for some time. When you stake cryptocurrency, you are locking up tokens for a set length of time in order to gain incentives. Although rates vary per project, staking often provides more than 10% APY, whilst savings accounts at banks seldom top 0.5 percent.

The estimated interest you will receive by staking a specific token quantity is referred to as the APY. Some projects additionally provide tokens as a staking incentive. You earn another token from the same project by staking the token for a set period of time.

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While staking, your tokens will be locked (unusable). As a result, you won’t be able to sell them if their price falls. This brings up another disadvantage: market volatility. The cryptocurrency market, like any other, is volatile. Prices are subject to change at any time. Staking has a higher risk than regular banking activity due to its volatility.

Which is preferable: staking or liquidity provision?

DeFi (decentralized finance) trading strategies include staking and liquidity provision. At first glance, one is not superior to the other; it all relies on your financial plan.

Because many projects do not have a mandated staking time, staking is a superior long-term DeFi approach. This implies you may stake tokens for as long as you want, even indefinitely, while earning dividends.

Anyone who bets has the opportunity to earn a large APY, or interest, on their investment. Many initiatives also provide tokens as prizes. The potential to earn a passive income is the most significant advantage of staking. Staking allows you to sit back and relax while your tokens do the job. Staking is also an excellent method to support the initiatives you care about. It boosts their coin and lends validity to the idea. Finally, it integrates network security with user incentives by compensating users for participating in proof-of-stake protocols.

The most obvious advantage of liquidity provision, on the other hand, is that it is decentralized and available to anybody. Liquidity availability also enables other DeFi exchange options, such as liquidity mining. Users pool their tokens and get rewards in freshly created tokens according to the smart contract in liquidity mining.

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Providing liquidity is a high-risk, high-reward DeFi activity. There is a danger of temporary loss whenever money is provided to an AMM. This implies that when you utilize your tokens to offer liquidity rather than holding them in your wallet, they lose some of their value. Furthermore, the token price may fluctuate between the time the order was placed and the time it was completed. This is referred to as price slippage.

Furthermore, no third parties are ensuring the security of your cash, only the smart contract. If the smart contract fails or is hacked, you may lose your cash.

Finally, you must be wary of dishonest schemes. Scam projects may alter smart contracts once liquidity provision has commenced, stealing your dollars. Make certain that any liquidity pools in which you participate have had their smart contracts examined.

If you are comfortable taking significant risks, you should look into liquidity offerings. If not, it’s best to ignore it at this point in your crypto adventure.

What are the pros and cons of staking?

Pros

● High APY
● Simple process
● Earn tokens as rewards
● Great way to earn a passive income
● Support the projects you love

Cons

● Locked-up tokens
● Higher risk than banking
● Market swings

Assume you wanted to bet on Everstake as one of the ecosystem’s primary validators. Once your wallet is set up and financed, you may pick which tokens to stake: in this example, we’ll use Elrond tokens (EGLD). Elrond’s minimum staking amount is 1 EGLD. If you staked one EGLD on Elrond, you would be charged 0.00018138 EGLD. Staking expenses are unavoidable, but the returns far outweigh them! Stakes may earn you roughly 12.1% APR. At that rate, your 1 EGLD stake would yield 0.121 EGLD.

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What are the pros and cons of liquidity providing?

Pros

● Decentralized
● Liquidity mining

Cons

● Impermanent loss
● Smart contract risk
● Dishonest projects
● Price slippage

Assume we wanted to create liquidity for Elrond coins. To create a token pair, we’ll utilize MEX to create an EGLD/MEX (Maiar Exchange) liquidity pool.

A liquidity pool’s token pair percentage must always be 50/50. So, if we want to provide 1000 USD liquidity and EGLD is worth $250 and MEX is worth 0.10 USD, we need to add 2 EGLD and 5000 MEX. We use an AMM to swap those two EGLD for MEX. After that, we may add our token pair to the pool to generate liquidity. The additional liquidity provides us with LP tokens, in this example LP-EGLDMEX. The LP tokens allow us to participate in the pool.

Conclusion

As DeFi evolves, there are more and more opportunities to earn cryptocurrency. Staking and liquidity provision are two of the most basic and lucrative solutions. Staking is arguably the finest alternative for individuals who need to make a speedy turnaround.

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