Mining, Staking, Liquidity Pools, and Yield Farming; What’s The Difference Between These Investing Strategies and How Can You Use Them?

Have you ever heard the saying, “there are a million ways to make $1 million?” It’s true. It’s also true that there are a million ways to earn Bitcoin. You can work for it, engage in short-term or long-term trading, build a business that accepts cryptocurrency as payment, buy shares in companies that own cryptocurrencies, along with any number of other things to keep adding more value to your cryptocurrency wallet.

In this edition of Netcoins Progressive Investor, you’re not going to learn about all of the above. Instead, you’ll learn about how to use actual coins and tokens you already own to earn more. There are also many ways to do that. But to make it easy let’s cover four different methods:

• Mining
• Staking
• Liquidity Pools
• Yield Farming

If you’re a cryptocurrency investor with some experience, you’ve probably heard of all four of the above, yet you still may not know the difference. Don’t worry. You’re about to learn that and get comfortable with understanding how you can use each of the above methods as part of your overall cryptocurrency investing strategy.

Let’s get started!

What Is Bitcoin Mining?

To be clear, many different cryptocurrencies allow users to earn more coins through mining, but Bitcoin is the originator of the whole idea.

The Bitcoin blockchain validates transactions using computing power provided by users who act as nodes that secure the network. Mining is the process of using computing power to solve complex cryptographic puzzles. Computers on the network compete against each other to solve these cryptographic puzzles first, validating blocks of transactions. The winning miner gets Bitcoin as a reward.

The whole idea of computers validating transactions by putting in work to solve these complex puzzles is called a Proof-of-Work consensus algorithm.

How Can You Earn More Cryptocurrency Using Mining?

Bitcoin is the most valuable cryptocurrency in the world by market capitalization. If you started mining in 2010, you’d be rich beyond your wildest dreams today. The best part is, if you started early, you could have used nothing more than a personal computer to earn Bitcoin.

Unfortunately, there is a catch! Bitcoin is programmed to make mining new coins more difficult as time goes on. To add to that, the number of new coins you can earn from solving puzzles correctly cuts in half approximately every four years.

That’s why today, you only have two options for getting involved in Bitcoin mining. You either need to invest large amounts of capital in warehouses filled with computers that use enough power to solve some of the world’s most complex puzzles, or you need to join a mining pool and earn just a fraction of the rewards based on the level of your investment.

The good news is Bitcoin isn’t the only game in town when it comes to mining cryptocurrencies. Litecoin, Bitcoin Cash, Digibyte, and Siacoin represent just a handful of many altcoins that still use a Proof-of-Work algorithm and allow you to be a miner without having hundreds of millions of dollars worth of mining equipment in your backyard.

What Is Staking?

Staking is a more environmentally friendly way of validating transactions. You don’t need computing power to participate in staking. The reason it’s called staking is that you are allowing the blockchain to temporarily hold onto your coins in return for the opportunity to be selected as a validator, validate transactions, and receive a corresponding reward for your participation. Read more about what crypto staking is.

The Ethereum blockchain is currently moving from a Proof-of-Work consensus algorithm to a Proof-of-Stake consensus algorithm. Once that happens, investors like you will no longer need mining equipment to earn Ethereum tokens, but you will need at least 32 Ethereum tokens if you hope to stake on your own. Otherwise, you’ll have to join a staking pool and earn a fraction of the return.

How Can You Earn Cryptocurrency Using Staking?

Ethereum isn’t ready for you to capitalize on staking yet. It’s still going through a 2.0 upgrade. The good news is many other blockchains already use a proof-of-stake algorithm. Cardano, Tezos, and Algorand are just some of the altcoin projects that will allow you to earn more of their tokens just for staking your coins.

What Are Liquidity Pools?

Liquidity pools are pools of tokens that are used to facilitate trading. They are used by decentralized exchanges (DEXs). Why?

Centralized exchanges use an order book to facilitate trades and ensure that enough liquidity is available for users like you to trade your Bitcoin for Ethereum and vice versa for example. Netcoins make sure that the market is as fair and efficient as possible.

In a decentralized exchange, there isn’t a company backing this process, so the exchange needs users to provide the necessary liquidity to facilitate cryptocurrency trades. You provide an equal portion of two different cryptocurrencies, say Ethereum and Bitcoin, to a pool. In exchange, you get a percentage of the transaction fees users generate.

While investing your crypto into liquidity pools can certainly be profitable, there is also a risk that if your pool is not facilitating a high volume of transactions, you’re actually costing yourself other opportunities in the market.

How to Use Liquidity Pools to Earn More Crypto

Protocols like Curve Finance and Balancer allow you to add liquidity to both sides of their ledgers and capitalize on transaction fees that come rolling in. Keep in mind that when you engage in the strategy you do have to pay smart contract fees and you have to be aware of what you’re doing. Sending crypto to different addresses to engage in liquidity pools can be confusing and if you don’t do the math right, you can lose money when smart contract fees are high. That said, in addition, to earn a cut of transaction fees, you can also earn liquidity pool tokens. 

As a hypothetical example, let’s say you’re providing liquidity to a BTC/ETH pool on Curve Finance. You’ll get a cut of the fees that go through that pool plus some Curve Finance tokens as a reward for your participation.

What is Yield Farming?

The whole point of yield farming is to take your cryptocurrency, move it between different DeFi protocols and try to find the best possible return on your investment. The process of farming involves three key principles: liquidity mining, leverage, and risk.

Liquidity mining is essentially what is described in the section above. You provide an equal amount of two different cryptocurrencies and earn a liquidity pool token in exchange for your contribution as well as a cut of the transaction fees that go through the pool.

In crypto investing, gaining leverage means borrowing funds and reinvesting those borrowed funds to amplify your gains. This is a common investment strategy for high-risk/high-reward individuals. But be warned. 

Borrowing funds to amplify gains also means you’ll amplify your losses if you’re wrong. In a fast-moving asset class like cryptocurrency, you might be able to borrow two, three, four, or even 10 times your investment to try to earn a huge return fast. 

But the more money you borrow through leverage, the less margin you have to the downside before the protocol you’re using liquidates your assets to cover your potential losses. 

Be very careful when using an investing strategy that involves borrowing crypto that needs to be paid back to a protocol or exchange. That’s the third and arguably most important principle fully described for you. Risk tolerance. 

How Can You Use the Above Investing Strategies to Earn More Cryptocurrency?

The truth is, you can use one, some, or a combination of all of the above investing strategies to accelerate your crypto gains and minimize potential losses. Coming up with the right investment strategy for yourself involves experimenting, understanding your risk tolerance, and staying committed to learning as much as you can. Here are some of the factors most investors should consider before they implement the above strategies:

• How much of your cryptocurrency holdings are you willing to lose?
• Are you a short-term investor or a long-term investor?
• What are your financial goals?
• Are you a beginner, intermediate, or advanced cryptocurrency investor?
• How comfortable are you interacting with different protocols and smart contracts?
• What other investments do you have outside of cryptocurrency?
• What debt or immediate credit obligations do you need to take care of?
• Do you consider yourself to be a low-risk, moderate-risk, or high-risk investor?
• Do you know how to conduct proper due diligence on a new or existing crypto project?
• Do you have an in-depth understanding of fundamental, technical, on-chain, or off-chain analysis?

The above questions are by no means a complete list. Answering them is merely an opportunity to pause and reflect on the kind of crypto investor you are and what your goals might be. There is no such thing as a perfect crypto investing formula.

The whole point of Bitcoin in cryptocurrencies is that it allows you to be your own bank. This gives you a tremendous amount of power over your wealth. But with great power comes great responsibility. If you send your crypto to a DeFi project that gets hacked because of the smart contract flaw, or you send it to the wrong address, or you borrow funds and the market goes down 30%, there is no customer service team to complain to. The rewards are all yours, but so are the risks.

Assess both appropriately and you can have success both in the short term and the long term.

Start Your Crypto Investing Journey by Signing up for an Account with Netcoins

Netcoins is the most trusted cryptocurrency exchange in Canada and you can sign up for an account for free. You don’t need to pay fees on your deposits, and you can put crypto or Canadian dollars in your Netcoins account easily. Send the crypto to your Netcoins wallet address, or deposit dollars via e-transfers, online billing or bank wires.

Just by getting into the market, you’re already an investor. But if you decide you want to go beyond simply HODLing, at least now you have a deeper understanding of a few of the different investing strategies you can use to your advantage.

If you’re looking to purchase Bitcoin or other cryptocurrencies, Netcoins is a fully regulated crypto trading platform in Canada. Simply create an account with Netcoins, fund it with an e-Transfer (more funding options available) and head to the trade page to buy ETH. Sign up today!