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Liquidity Mining In DeFi Explained

UNISWAP, the largest decentralised exchange, was subject to a code attack in which attackers stole 1,278 ETH with a code vulnerability in this exchange. It is great because we can create any new trading pair and add immediate liquidity as long as plenty of people add funds to the pool. A traditional P2P exchange maintains an order book where traders can add orders.

  • Ethereum and Tether are one of the most popular pairings on Uniswap, so we’re going with those options.
  • Since exchanges depend on liquidity, they reward holders for providing liquidity to a particular token.
  • Liquidity mining is the process of providing liquidity to decentralized exchanges (DEXs) in exchange for rewards.
  • Higher yields are usually attached to pairings that involve smaller crypto projects with short operating histories and limited market caps.
  • You invest $1000 (1 ETH and 10’000 DOGE) thinking that you’ll make $1000 per year + if DOGE and ETH rise in value you end up with even more tokens.

Furthermore, problems and vulnerabilities are discovered regularly in these DeFi projects, putting user funds in even greater danger. It all started when one of the popular DeFi lending platforms – Compound, started distributing its governance tokens called COMP to its users on the network. On Compound, users were already involved in lending and borrowing activities, and “Yield Farming” is one such case of earning interest on deposits. The Automated Market Maker (AMM) is a collection of smart contracts that plays the role of a bank in the digital ecosystem. This means that the AMM maintains the lending and borrowing rates of the protocol based on various factors such as available liquidity.

Liquidity mining explained

Liquidity mining is a process in which crypto holders lend assets to a decentralized exchange in return for rewards. These rewards commonly stem from trading fees that are accrued from traders swapping tokens. Fees average at 0.3% per swap and the total reward differs based on one’s proportional share in a liquidity pool. At the heart of this, services such as staking or liquidity mining lie somewhere in the middle, offering investors to make more with their crypto. Rather than simply hodling their crypto assets, users can put them to use by placing them in marketplaces.

Liquidity providers receive rewards in the form of tokens, which are specific to the platform they are providing liquidity too. The process involves depositing assets into a liquidity pool and receiving rewards in exchange for the provided liquidity. Although liquidity mining minimizes favoritism, it’s important to note that distributing tokens to liquidity providers doesn’t end the inequality of token distribution.

Liquidity mining is focused on providing liquidity to DEXs, while staking is focused on helping to secure and validate transactions on a blockchain network. Liquidity mining is important because a DEX needs liquidity to enable the trades between different token pairs and this incentive strategy enables users to contribute liquidity to facilitate those trades. This means that the majority of liquidity pools are between trading pairs where users can deposit the two different cryptocurrencies depending on the pool. An important factor in this context is also the emergence of new trading venues. Until now, cryptocurrencies were traded exclusively on a centralized exchange (CEX).

Liquidity mining explained

As a result, you can get massive relief from any concerns of favoritism. Having liquidity is important for individuals and firms to pay off their short-term debts and obligations and avoid a liquidity crisis. Liquidity is the ease of converting an asset or security into cash, with cash itself being the most liquid asset of all. Other liquid assets include stocks, bonds, and other exchange-traded securities.

Other than its consensus mechanism, the BSC blockchain is almost identical to Ethereum and can even be accessed through the popular MetaMask Ethereum wallet.

Token swaps allowed the possibility of trading one token for another one in a liquidity pool. Users had to pay specific fees for every trade, such as 0.3% of the value of swapped tokens on Uniswap. Other than the opportunity for earning yield, different protocols can also feature reward incentives such as governance tokens. In addition, liquidity mining with Bitcoin becomes possible when the native token of a DEX becomes popular on the grounds of utility. With a popular native DEX token, you can easily swap it for Bitcoin and Ethereum or trade them for better profits.

Tangible items tend to be less liquid, meaning that it can take more time, effort, and cost to sell them (e.g., a home). Cash is the most liquid asset, followed by cash equivalents, which are things like money market accounts, certificates of deposit (CDs), or time deposits. Marketable securities, such as stocks and bonds listed on exchanges, are often very liquid and can be sold quickly via a broker. Gold coins and certain collectibles may also be readily sold for cash.

The more an LP contributes towards a liquidity pool, the larger the share of the rewards they will receive. Different platforms have varying implementations, but this is the basic idea behind liquidity mining. By depositing their assets into the Defi platforms, the (LPs) make it easier for traders to get into and out of positions with the trading fees partly used to reward them. On the other hand, mining employs the Proof of Work method, in which liquidity providers receive new coins that the protocol’s algorithm has freshly minted.

Liquidity mining is booming — Will it last, or will it bust? – Cointelegraph

Liquidity mining is booming — Will it last, or will it bust?.

Posted: Sat, 27 Mar 2021 07:00:00 GMT [source]

You can find a list of the good and the bad platforms in a pinned post here in the Liquidity Mining subreddit. Increasingly, new investment products are emerging that are organized in a decentralized manner. The complete automation of such protocols often makes them cheaper and more secure than conventional applications. Yield farming is closely related to liquidity mining, but it’s not the same thing. This is a broader strategy, tapping into many different DeFi products to produce generous APY returns.

Cryptocurrencies are inherently volatile and you should be prepared for big price swings on a daily basis. Your life savings probably don’t belong in a high-yield liquidity mining account. You can pick one of several reward tiers tied to different what is liquidity mining interest rates charged to traders who actually make use of the digital funds you’re providing. Very common cryptocurrencies and stablecoins typically lean toward the lower end of the pool fees; rare and exotic coins often carry higher fees.

In this way, developers manage to accumulate a solid user base before the platform is fully functioning. Consequently, marketing a platform helps collect funds for liquidity, which can be locked by developers for extended periods. Liquidity essentially refers to a fund’s liquidity, which is defined as the ability to buy and sell assets without causing any sharp changes in the asset’s market price. This is a key element in the functioning of either a new coin or a crypto exchange and is dependent on some parameters, including transaction speed, spread, transaction depth, and usability. Although yield farming is based on liquidity mining, we will use the next lesson to figure out the differences between them and discover which method is more profitable.