When it comes to decentralized finance (DeFi), I always loved the idea of DeFi replacing banks, payment processors, and lending businesses. Another huge application of DeFi is trading exchanges.
I’ll admit that through the years, I have mostly purchased my crypto through centralized exchanges (CeFi) due to the ease and friendly user interface. But in 2021, DeFi exchanges have stepped up their game in the areas of total tradable assets, lower trading fees, and improved user interface.
This is where projects like UniSwap (Ethereum), SushiSwap (Ethereum), and PancakeSwap (Binance Smart Chain) come into play. They are DeFi exchanges directly competing with players like Coinbase, Gemini, and kraken for trading volume. It’s actually gotten to the point where looking at volume in North America, we see that Defi is continually becoming a larger % of the trading volume.
The cool thing with DeFi is that you can actually take part in the decentralized exchanges and make money by being a liquidity provider and earn money through the automated market maker (AMM) model. Say what now?
That is exactly what we are diving into today’s article around PancakeSwap and farming CAKE.
I’m by no means saying PancakeSwap is the best DeFi exchange, but I did like the user interface and also wanted to interact with the Binance smart chain (BSC) which is what the project runs on. Read this article to learn more about BSC.
There are main features of PancakeSwap which we will cover. You can use the exchange feature to trade tokens in an instant. Farming allows you to provide liquidity to different trading pairs and allows you to earn CAKE tokens in return for your service. You can also stake CAKE in different staking pools to secure the network and ensure the validity of new transactions that are being written to the blockchain.
They also have Non-Fungible Token markets (NFT), Initial Farm Offerings (IFO), and a Lotto feature (but I won’t be covering in this article).
Before you can use anything related to PancakeSwap you need to have or download a wallet you can connect to the website.
In order to get a taste for the whole process, I bought 0.31 BNB from crypto.com to send to a browser wallet.
For this part I originally tried to set-up MetaMask as I already had that wallet, but went with the Binance Chain Wallet as I was having issues sending BNB from crypto.com to MetaMask (even though I had the BSC network connected, crypto.com was saying the address was invalid and wouldn’t send). You can of course pick any of them to your liking.
You can see I sent a smaller amount first because I am always a little paranoid when starting a new process around crypto, since if you screw up it’s just gone. I think we all deal with this 🙂 (even more so with large 4 figure transactions).
Once the BNB hit my Binance Chain Wallet, I was ready to connect it with PancakeSwap.
And that’s pretty much it. Once connected, you’ll see your BNB balance in the wallet and you can start using the website which will be synced up with your browser wallet.
If you are using PancakeSwap as a exchange, this is the main feature you are looking for.
Want to buy that sweet sweet BABYDOGE? Maybe dip your toes into some ALPACA? Well with a DeFi exchange, you are more likely to find these extremely small cap tokens (whether they have utility or meme strength).
You can see above you can swap some BNB for BABYDOGE and you end up paying .00001 fees to the liquidity provider for this trade. Here is the breakdown further of how much is paid in fees.
Total fees is 0.25% of trade value.
- – 0.17% to LP token holders
- – 0.03% to the Treasury
- – 0.05% towards CAKE buyback and burn
That 0.25% sounds pretty good considering some exchanges charge close to 3% of a trades value. Why charge so much? Well the centralized exchange is a much larger structure with more expenses and they are trying to make money at the end of the day.
DeFi is much leaner, but the downside risk is if there is some type of bug in the smart contract system. Now this project has been audited for security and has some insurance as well, but there is still always that risk.
Check out these PancakeSwap security audits:
Certik’s security audit of PancakeSwap and Certik’s Shield insurance
Slowmist’s security audit of PancakeSwap
Slowmist’s Auto-CAKE Pool security audit
Peckshield’s Prediction V2 security audit
Centralized exchanges have similar risk, but you do have customer support that you can reach out to.
Farming (Liquidity Mining)
Now that we know we can trade crypto freely without the need of a centralized exchange, there has to be incentive for people to provide liquidity for these swaps. That is where farming comes into play and what I have set up myself with a few hundred dollars (as a trial test to see if I would like to add more later on).
The first thing we have to decide is which pool we want to provide liquidity to. I decided to provide liquidity to CAKE-BNB and BUSD-BNB in order to see how the results may differ and to spread the risk across different pools.
You can see I have supplied these CAKE-BNB LP (0.384) and BUSD-BNB LP (1.63) tokens.
In order to add liquidity to a pool you must go to the Trade tab and click on “+ Add Liquidity”
But where did I purchase these LP tokens? This is the part that may seem confusing without getting help via a step by step guide.
You first need to have a 50/50 split of tokens purchased and in your connected wallet for LP tokens to be created.
So with my BNB that was sent to my wallet. I bought CAKE and BUSD tokens to make it so my wallet was now around 50% BNB, 25% CAKE, and 25% BUSD (It’s important to leave some BNB in the wallet outside of this allocation to pay for gas fees throughout the process).
So for example, let’s say I had 2 CAKE in my wallet and the equivalent value of BNB was around .06.
When you have this 50/50 ratio you can then go ahead and create the LP Tokens. You then go to the Farm tab and click on the Enable Farm button for the LP pairs you have created. You’ll go through some confirmations and boom! You are now providing liquidity for that trading pool and get a piece of those swaps based on your % of the liquidity pool.
Now the CAKE is accumulating in the smart contract and in order to get the CAKE into your account, you will need to click the harvest button. Now here is where you need to be careful depending on the amount of money you are dealing with.
In order to harvest there is a gas fee and if you are harvesting .004 CAKE after 24 hours for 10 cents of value when the gas fee is 50 cents that doesn’t make any sense. So the lower the amount the less frequent you would harvest to avoid the fees adding up, and you can also see it probably isn’t worth it to farm with $20 of LP tokens as the fees will eat into any earnings as a large %.
If you are trying to figure out how much CAKE or $ you can make for a period of time, the website has a built in ROI Calculator (pretty awesome feature)!
If you decide you no longer want to provide liquidity, you can click the “-” button to unstake at any time. You can also add more LP tokens with the “+” button.
Another way to make money with CAKE is by staking it. So you can actually take CAKE you earned from farming and turn it into even more CAKE. So much CAKE!
Similar to other proof of stake protocols, this staking feature is there for governance and to make sure that transactions are being validated on the blockchain.
Pros and Cons
Let’s start off with the obvious benefit and that is you are getting rewards for providing a service for farming or staking. You can stack your crypto holdings even more over time without adding any additional fiat capital.
At this point you may be asking, how can there be downsides when you are continually staking CAKE! Well there are two main reasons.
If you are farming, you may run into impermanent loss. This article goes into it in great detail about it, but at a high level it is when you incur losses through the volatility of the LP tokens changing in price at a fast pace and you could have ended up with more money by holding onto the underlying assets.
From the linked article here is the estimation of this type of loss.
- 1.25x price change = 0.6% loss
- 1.50x price change = 2.0% loss
- 1.75x price change = 3.8% loss
- 2x price change = 5.7% loss
- 3x price change = 13.4% loss
- 4x price change = 20.0% loss
- 5x price change = 25.5% loss
Now at the same time you are getting these rewards that may offset this entirely. Essentially the more volatile the assets are the higher these impermanent losses can be.
The second is simply by staking you are more likely to hold and if the price of the asset like CAKE explodes to the upside you may not sell to lock in profits from price appreciation. Staking and farming I would say compliments the long term holder in a project vs. someone that is looking to trade in and out for profits from price change.
At first it seems confusing, but it is rather simple once you complete the full process at least once and get comfortable with all the moving pieces from setting up your browser wallet to locking in the contract for liquidity provider tokens.
Hope the step by step instructions are helpful and feel free to share this information with others!