DeFi — or decentralized finance — is a way for investors to create income from peer-to-peer financial transactions. DeFi platforms give investors the opportunity to put their digital assets to work by providing liquidity to other investors. Doing this can be an easy way to generate passive income.
PancakeSwap is an example of a DeFi platform that allows investors to deposit cryptocurrencies into liquidity pools. Other popular DeFi platforms include Uniswap, Sushiswap, and Binance. This article will cover what PancakeSwap is, how it works, and the different ways investors can earn passive income using it.
The Short Version:
- PancakeSwap is a decentralized exchange that enables investors to generate income off of crypto assets.
- Users who provide liquidity can facilitate crypto swaps with other users eliminating the need to find buyer/seller pairs.
- Investors can earn additional income by staking CAKE tokens in liquidity pools or yield farms.
- PancakeSwap is generally considered a safe exchange due to routine third-party audits.
What Is PancakeSwap?
PancakeSwap is a decentralized exchange that allows users to trade coins without the need for a middleman. It's part of the broader DeFi ecosystem that allows individuals to conduct financial transactions directly with one another instead of going through a traditional institution like a brokerage firm.
The platform is built on Binance Smart Chain where investors swap BEP-20 tokens. This is similar to other decentralized exchanges like Uniswap.
One benefit of PancakeSwap is that it is built on Binance and not Ethereum, and therefore not subject to the same high gas fees.
Gas is essentially the transaction fee charged to process a transaction on the blockchain, and on a popular blockchain network like Ethereum, the demand (and associated fees) can skyrocket. However, Binance is a different blockchain with a different consensus mechanism. This makes coin swaps on PancakeSwap cheaper and it's one of the reasons that it's become so popular with investors.
What Is a DEX?
A DEX – or decentralized exchange – is a peer-to-peer marketplace where users can trade cryptocurrencies with one another. Unlike the stock market, for example, investors do not need an intermediary to facilitate exchanges on their behalf.
This is because trades that happen on a DEX are self-executing via smart contracts. These are essentially a series of functions that can automatically execute commands without human assistance.
Unlike working through a centralized exchange like Coinbase or Crypto.com, trades that happen on decentralized exchanges are typically non-custodial. Users are responsible for maintaining their own wallets and safeguarding the private keys to those wallets.
While this generally gives users more autonomy to make financial decisions, it also comes with its own risks. If an investor loses their private key, the assets in their wallet will be irrecoverable.
How Does PancakeSwap Work?
PancakeSwap is an AMM — or automated money maker — that allows users to provide liquidity directly to other users. They can do this by depositing their asset into a larger pool which other investors can withdraw from.
In most traditional securities exchanges, investors have to wait to be matched with another investor via an order book in order to make a trade. Essentially a seller must wait to get matched with a buyer looking to purchase a security at the same price point. However, on PancakeSwap and other DEX’s, investors can make immediate trades from the pool without waiting.
Investors can generate income simply by providing liquidity. Users who add liquidity to PancakeSwap are issued liquidity provider tokens called CAKE-BNB.
CAKE is PancakeSwap’s native cryptocurrency token and BNB is Binance’s native crypto. Holders of both are eligible to receive a portion of trading fees that are collected on the platform. Whenever a seller makes a swap they pay a 0.25% trading fee. Out of that fee, 0.17% is allocated to liquidity providers in CAKE-BNB.
To stake on a decentralized platform, investors “lock” their cryptocurrency into smart contracts. Investors earn a high-interest APY for staking their cryptocurrency just like an investor would earn a higher interest rate for setting their money aside in a Certificate of Deposit rather than a traditional savings account.
To be able to stake on PancakeSwap, investors first need to provide liquidity on the platform. Investors can earn CAKE by participating in other income-generating activities such as staking and yield farming. PancakeSwap also hosts an in-platform lottery that users can play using CAKE to generate even higher returns.
CAKE tokens can be staked in high-yield staking pools called Syrup Pools.
In exchange for staking or locking their CAKE in these pools, investors are compensated with even more CAKE. This is a great way that users are able to earn passive income, allowing investors to compound their CAKE holdings and increase the value of their original investment over time.
Yield Farming is similar to staking but it involves strategically staking digital assets in high APY pools to earn the highest yield possible. A yield farmer is an investor who moves digital assets from one liquidity pool to another in order to “harvest” a return from liquidity pools offering high APYs. This is similar to moving a checking account from one bank to another in order to benefit from a higher interest rate.
To generate passive income through yield farming on PancakeSwap, an investor needs to provide liquidity to the exchange and stake their CAKE in high-APY yield farms. They will be able to move their assets around as rates change.
One key difference between yield farming and regular staking is the risk of impermanent loss. Anytime you move assets around you risk selling them for a lower price than you originally bought them for. Cryptocurrencies in general are volatile assets which means their prices fluctuate frequently. When an investor moves CAKE into a PancakeSwap yield farm they risk withdrawing less money than they originally put in if the price changes.
Yield farms generate a higher reward than Syrup Pools. But as with most investments, higher potential returns go hand in hand with higher risk.
Something unique to PancakeSwap is its in-platform lottery. The lottery allows investors to buy lottery tickets to win prizes paid out in the form of CAKE tokens.
Just like with the Powerball lottery, PancakeSwap users can buy a lottery ticket for 10 CAKE tokens. The ticket gives users a random four-digit combination of numbers. If the numbers on a user's ticket match the winning lottery ticket, then users can win the jackpot or 50% of the entire lottery pool.
Each lottery round takes about six hours and users can play as often as they wish. While playing the lottery is not as passive as staking, it gives users an opportunity to put their CAKE to work by potentially winning a large jackpot.
Is PancakeSwap Safe?
No investment is considered completely safe, especially when it comes to cryptocurrencies. When it comes to DEXs, however, PancakeSwap is considered to be on the safer side.
One reason is that PancakeSwap has a wide user base, which means other users are constantly injecting new liquidity into Syrup Pools, it is easy for an investor to withdraw their assets at any time.
PancakeSwap is also regularly audited by CertiK and Slowmist. These are two blockchain security firms that routinely evaluate how well PancakeSwap can hold up to cybersecurity threats and exposure to hackers.
One thing worth noting is that there is an ongoing probe by the Justice Department against their parent platform, Binance. While the outcome of this probably won’t affect PancakeSwap too much, the platform is built on the Binance Smart Chain.
Despite PancakeSwap’s good reputation investors on any decentralized exchange are still exposed to risk if they lose their private keys or if their wallets are hacked.
Pros and Cons of PancakeSwap
While there are benefits of using a decentralized exchange like PancakeSwap, it's important to evaluate the risks to ensure investors are making the right investment decisions.
- Trades on Binance come with lower fees than other DeFi platforms built on Ethereum
- Users have the ability to generate income from providing liquidity, staking, yield farming, and playing the lottery
- PancakeSwap is rigorously audited by external blockchain security firms
- Investors may be exposed to impermanent loss
- Investing in high-yield pools is a higher risk than providing liquidity or staking
- Binance isn’t easily compatible with popular hot wallets
The Takeaway: Should You Use PancakeSwap?
PancakeSwap is one of the most popular and user-friendly AMMs in the DeFi space. It allows investors to put their digital assets to work by generating income from staking, yield farming, and playing the lottery.
Users considering getting on PancakeSwap should heed the guidance of any relatively volatile investment: Don’t invest more than you are willing to lose.
While there are a growing number of AMM platforms available, PancakeSwap is built on Binance which costs less than other platforms built on Ethereum. This can be a significant cost saving for investors to consider and can allow them to increase their returns.
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