Liquidity Mining in DeFi: What Is It & How Does It Work?

Liquidity Mining in DeFi: What Is It & How Does It Work?

Now that you know what liquidity mining is, the next step is to consider whether it is a good investment approach. Liquidity mining can be a good idea, especially since it’s extremely popular among investors as it generates passive revenue. This means that you can profit from liquidity mining without having to make active investment decisions. Crypto market liquidity was a problem for DEXs on Ethereum before AMMs came into play. DEXs were a new technology with a complex interface at the time, and the number of buyers and sellers was low.

  • Tokens based on a blockchain, NFTs are used to guarantee ownership of an asset.
  • Very common cryptocurrencies and stablecoins typically lean toward the lower end of the pool fees; rare and exotic coins often carry higher fees.
  • The gold bar is considered more liquid because it’s much easier to find a buyer for gold than it is for rare books.
  • As a result, investor X has lost the potential gains on crypto A due to the liquidity mining investment.
  • From the dashboard, you can also add more liquidity to earn more rewards based on your share of the pool.

The liquidity mining fever is quite recent, in fact, many attribute to Compound this fact. It all started on 15 June of 2020, when Compound, took out its governance token COMP. At the time, the token came out with a market price of about $ 60 USD, and its market capitalization was $ 0 USD. DEXs are cryptocurrency exchanges that allow peer-to-peer transactions, eliminating the need for an intermediary like a bank.

what is liquidity mining

Participants contribute cryptocurrencies to liquidity pools for a certain exchange in return for tokens and fees depending on the quantity of crypto they contributed to the pool. Built on Ethereum, Aave is referred to as one of the most popular decentralized money market protocols. It allows its users to lend and borrow their cryptocurrencies in a secure and efficient manner.

It is a fast, cheap, and eco-friendly blockchain due to its use of the Proof of Staked Authority (PoSA) mechanism. Other than its consensus mechanism, the BSC blockchain is almost identical to Ethereum and can even be accessed through the popular MetaMask Ethereum wallet. Crypto holders must contribute equivalent quantities of tokens to DEXs in terms of value.

what is liquidity mining

These tokens provide you with a certain degree of voting power in the DEXs you’ve invested in. In addition, you can utilize tokens for a certain exchange to alter the protocol’s properties if you have them. Decentralized exchanges can’t function without a certain level of liquidity for traders who wish to swap tokens from various cryptocurrencies. Therefore, exchanges are enticed to compensate you for your contributions when you supply liquidity in this way.

These assets can be highly valuable, but often lack a liquid market, requiring specialized buyers and potentially lengthy sales processes that involve hiring brokers. Similarly to crypto, liquidity is influenced by several factors, including the number of shares outstanding, trading volume, and the bid-ask spread. A stock with a large number of shares outstanding and a high trading volume is generally more liquid than a stock with fewer shares and less trading activity. Having sufficient cash or easily convertible assets is necessary to cover expenses, such as salaries and bills. Insufficient liquidity can lead to financial difficulties and challenges in meeting obligations. Fresh projects may be established without any type of authentication or registration because all decentralized protocols provide anonymity.

Liquidity mining is pretty similar to providing liquidity, as both address you supplying liquidity for the exchange. You can use LP tokens for various purposes, including staking, further liquidity providing, and special programs sporadically offered by the exchanges. Governance tokens are an important aspect in liquidity mining since they may be used to identify another type of reward with governance capabilities.

If there is no capacity expansion, more transactions ultimately increase the fees. Many crypto experts compare the DeFi hype caused by liquidity mining with the ICO hype in 2017. But the main difference is that DeFi platforms already have fully functioning products and services.

what is liquidity mining

It offers users much sought-after flexibility to carry out transactions anytime from anywhere and needs only a stable internet connection. DeFi grants its participants a unique opportunity to conduct their transactions considerably faster and drastically reduce fees related to transfers. Just as importantly, given that intermediaries are removed from the process, users manage to gain some additional benefits not present in traditional finance.

This allows traders to make larger trades without causing drastic price fluctuations. When the price of the tokens you’ve supplied to a liquidity pool changes from when you originally deposited them, it’s called impermanent loss. The Ethereum network is the most popular blockchain for smart contracts right now. It employs the proof-of-work (POW) consensus, which needs processing fees, i.e., gas costs, despite plans to migrate to the proof-of-stake (POS) consensus. When IDEX originally launched DeFi liquidity mining, it was in the guise of a reward scheme that offered specific incentives to exchange members. Participants were awarded IDEX tokens instead of locking funds in a separate pool once they decided to offer liquidity.

what is liquidity mining

The locked-in funds then serve as the lifeblood of the decentralized crypto exchange. Without this liquid base of digital capital at their fingertips, the DEX trading systems would quickly grind to a halt. In the wake of blockchain adoption, many liquidity mining investments occur on newer exchanges. One benefit of liquidity mining that is sometimes overlooked is that it builds a trustworthy and dedicated community. When a liquidity mining system is implemented, liquidity providers frequently become more active in the community while the exchange expands. Individuals who provide liquidity are more likely to use the system and maintain tokens after investing in digital assets.

Profits can be pretty solid, considering the number of decentralized exchanges, the growing demand, and each exchange craving a tiny bit of liquidity. Sometimes smaller exchanges attract fewer providers, and you get a bigger share of a smaller reward, resulting in higher profits compared to the likes of Uniswap. Once the governance tokens turn viral, you can use them to add liquidity outside of the platforms for major trading pairs featuring Bitcoin and beyond. An alternative would be simply swapping your gained tokens to Bitcoin, Ethereum, or any other token available and traded for profits. Participating in these liquidity pools is very simple as it involves depositing your assets into a common pool called a liquidity pool.

In contrast, liquidity mining involves depositing funds to a decentralized finance (DeFi) platform, which is then used to facilitate trades, earning rewards. Both methods share similarities, but they differ in terms of risks, rewards, and time required to earn rewards. Before choosing a strategy, it is imperative to understand the differences between them.


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