PancakeSwap (CAKE 2.88%) was introduced just a year ago this month, but it has quickly became the largest automated crypto market maker -- a provider of trading liquidity -- on the Binance Smart Chain (BSC). PancakeSwap users have staked (meaning users are holding their crypto in digital wallets) more than $5.6 billion on this decentralized exchange (DEX), compared to a market value of just $4.983 billion. That suggests the token is a bargain compared with peers such as Uniswap, which has a total value locked (TVL) -- a measure of how much is staked --that outpaces its market cap by a factor of 3.3.

Unlike many other cryptocurrencies, there's way more to PancakeSwap than simply buying and holding the tokens. Let's look at why it should be a top choice for coin holders. 

Breakfast morning pancakes garnished with blueberries, sliced bananas, and syrup.

Image source: Getty Images.

What is PancakeSwap? 

PancakeSwap is a token built on the Binance Chain BEP-2, which is run by Binance, owner of the world's largest cryptocurrency exchange, processing $27 billion worth of trades a day on average. Former Binance employees also happen to be the ones who started PancakeSwap. What's more, the protocol is audited by leading smart-contract security firm, CertiK. Like auditors who certify the financial statements of publicly traded companies, one can usually give more trust to audited DeFi projects than unaudited ones.  

There are three ways to make money when it comes to investing in CAKE.

First, coin holders can purchase BEP-2 CAKE tokens directly on exchanges and store them, profiting as prices rise. 

But its main beauty comes from the use of its Binance Smart Chain CAKE tokens, or BEP-20. Users can swap between BEP-2 and BEP-20 CAKE by using a digital wallet like TrustWallet. The two are equivalent, except BEP-20 CAKE enables use of smart-contracts, self-executing agreements that are triggered when certain conditions are met use.

That brings up the second layer of returns. A user can connect their wallet and stake BEP-20 CAKE on PancakeSwap and earn more than 60% per year in rewards. This comes from:

  1. Payments made by other blockchain developers to list or advertise their tokens on PancakeSwap
  2. A CAKE lottery
  3. Fees for validating CAKE transactions
  4. The issuance of new CAKE to incentivize adoption

However, don't expect yields always to be this high, especially when other blockchain developers affiliated with CAKE have gained enough traction and stop issuing marketing rewards. In addition, the rate of CAKE emission, or coin creation, is about 100 million per year, compared to a total circulation of about 221.8 million tokens. So the rate of supply increase is quite high (though still above staking yields). Imagine, for the sake of argument, if the interest rate on U.S. dollar deposits was 80%, but the inflation rate was 50%. The adjusted return in this case would be much lower than the nominal rate. 

What's more, users can also pledge their CAKE to offer liquidity for crypto-to-crypto trading on the PancakeSwap DEX, turning themselves into market markers for potential triple-digit percentage yields.

The lower the trading volume for an asset, the greater the spread between the bid and ask prices, and the more one can earn in potential commissions by providing liquidity. There now are 1,647 coins and 9,152 trading pairs listed on the Pancake platform, much more than on competitors.

Finally, PancakeSwap's smart contracts enable automatic restaking, that is, every CAKE a user earns can be put back into the staking pool, earning further "interest." It's similar to how bond investors can get compounded returns by reinvesting their coupon payments back into the underlying debt. With this setup, restaking CAKE can lead to yields as high as 83% instead of the regular 65% or so.

The verdict 

CAKE holders can get compound returns during bull runs but aren't subjected to compound sell-offs during bear runs. Nevertheless, in the worst case, investors could lose their CAKE principal.

But with yields this high, there's a margin of safety as the passive income one receives from staking can offset short-term market reverses. It is, therefore, a solid cryptocurrency to check out.