How To Earn Passive Income (and the Risks)

Most people buy crypto hoping its value will rise, but simply holding it isn’t the only way to earn. You can also put your crypto to work and generate passive income through staking, lending, and yield farming. However, before trying any of these investment strategies, you must understand how they work and the risks involved. 

What Is Crypto Staking?

Crypto staking is when you temporarily lock up your cryptocurrency to help a blockchain—the decentralized ledger that secures crypto transactions—run properly. By doing this, you support the blockchain’s network, meaning all the computers that work together to record and verify transactions, and you can earn extra cryptocurrency as a reward.

Only certain blockchains, called Proof-of-Stake (PoS) networks, use staking to verify transactions, while others, like Bitcoin, use a different system called Proof-of-Work (PoW).

What Is Crypto Yield Farming?

Crypto yield farming is when you provide cryptocurrency to a decentralized platform, usually in liquidity pools, so the platform can use it for trading, lending, or other financial activities. In return, you earn crypto rewards.

“It’s like renting out your crypto in return for transaction fees and/or additional tokens,” Lucas Wennersten, CFA, CFP, owner of 49th Parallel Wealth Management, told Investopedia. “Returns can be better than staking, but with more risk.” This is because your crypto is actively used in financial transactions, rather than simply being held as collateral to secure a blockchain, like in staking.

What Drives Returns

Returns from staking and yield farming are based on rates set by the platform you use. For example, Coinbase lets you earn a 3.85% APY by staking a cryptocurrency called USDC. Meanwhile, you could earn up to 10.3% APY by lending USDC (as of October 21, 2025).

However, these are nominal rates. Your actual returns can be affected by:

• Token supply and inflation: Many networks mint new tokens as staking rewards. If token supply grows faster than demand, the market price may fall, which can reduce the value of your rewards.
• Market volatility: Crypto prices can fluctuate sharply, which may increase or decrease the USD-equivalent value of your returns.
• Fees: Validator fees for staking and transaction fees can lower your effective yield.
• Liquidity and pool size: In yield farming, returns are shared among all participants.

In short, the advertised annual percentage yield (APY) is only a starting point. Your actual returns depend on network conditions, fees, and changes in token prices.

Understanding the Risks

Like any investment, crypto staking and yield farming come with risks. On top of earning less than expected due to changing return factors (mentioned above), you may face the following:

Staking Risks

When you stake crypto, you typically lock it up with a network validator—a participant that helps maintain the blockchain. If the validator or network fails, or if the validator misbehaves, you could lose some of your staked tokens through a penalty called “slashing” or miss out on rewards. Different blockchain networks have different rules for how much risk stakers face.

Yield Farming Risks

Yield farming usually involves providing your crypto to a protocol—a set of smart contracts on a blockchain that automatically handles lending, borrowing, or liquidity pools. Risks include:

• Impermanent loss: If token prices in a liquidity pool change significantly, your share could be worth less when you withdraw.
• Smart contract vulnerabilities: Bugs or exploits in the protocol can allow hackers to steal funds. Some platforms may offer limited insurance, but no system is entirely risk-free.

While crypto staking and yield farming can offer high returns, they carry unique risks. Understanding them can help you manage your exposure and make better investing decisions.

How To Choose a Platform 

“When exploring platforms for earning rewards on crypto, I recommend prioritizing ease of use, flexibility, and a secure environment, as well as full transparency about associated fees,” said Joe Wilson, chief evangelist at bunq, an online bank that offers crypto staking. “For staking, for example, you’d want a platform that’s easy to use and gives you the freedom to unstake your assets anytime.”

Taxes and Recordkeeping

Keep in mind that your crypto earnings are taxable. In fact, if you have any digital asset transactions, you must report them on your annual tax return. To make this easier, the Internal Revenue Service (IRS) recommends keeping records that document:

• Your purchase, receipt, sale, exchange, or any other disposition of the digital assets
• The fair market value, as measured in U.S. dollars, of all digital assets received as income or as a payment in the ordinary course of a trade or business

Keeping careful records of your crypto returns is especially important if you’re ever audited because it provides evidence to support your tax filings.

The Bottom Line

Ultimately, earning income through staking or yield can sound like easy money—but it requires understanding the trade-offs between reward and risk. With the right research and expectations, you can limit your risk and avoid being lured by unrealistic returns.

“I’d recommend starting with an approach that helps you learn,” Wilson said. “For example, something like flexible staking can be a good entry point. It lets you earn rewards on your assets but with the freedom to unstake at any time. This is ideal when you’re starting out, as it helps you begin to understand crypto without being tied to long-term commitments.”

Wennersten agreed: “Staking is the best strategy for beginners because it is the least complicated, and rewards are earned from the network, so there is less counterparty risk.”