What is liquidity mining? Yield farming explained

This will then impact the balance of the specific token you plan to withdraw. For instance, when you provide two volatile crypto assets as liquidity, it may offer greater rewards than providing two stablecoins. Stablecoins do not substantially fluctuate in value, but volatile assets like Binance Coin , among many others, can fluctuate by 10% or more at any https://xcritical.com/ time. Once participants give liquidity to a liquidity pool, they can earn rewards. These rewards are known as “LP” rewards, and they are allocated among liquidity providers based on their pool share. In Traditional Finance, market makers such as brokerage houses or firms provide trading services for investors in an effort to keep financial markets liquid.

This is too little time dedicated to test, detect, and fix all possible vulnerabilities. Because of this, hackers can detect backdoors and simply withdraw all the funds at once. Staking is the practice of pledging your crypto assets as collateral for blockchain networks that use the Proof-of-Stake consensus algorithm. Stakers are selected to validate transactions on Proof-of-Stake blockchains in the same way that miners help achieve consensus in Proof of Work blockchains. Before learning how liquidity mining works, it’s necessary to first understand liquidity pools. Progressive decentralization protocols don’t grant control over the platform to the community straight away.

High market liquidity ensures that both buyers and sellers execute their trades swiftly. Citadel Securities, the New York Stock Exchange , and American Stock Exchange are just some of the hundred market makers that keep the markets liquid. The end result is a symbiotic relationship where each party receives something in return. Exchanges receive liquidity, LPs fees, and end-users have the ability to trade in a decentralized fashion.

• In the context of DEXs and AMMS, DeFi specifically made it possible to increase one’s capital by lending it to newly built trading platforms.
• Users simply deposit their assets into a pool to participate in these liquidity pools, similar to sending assets from one wallet to another.
• Liquidity mining is a process in which crypto holders lend assets to a decentralized exchange in return for rewards.
• The essential advantage of investing in liquidity mining is that the yield is proportional to the risk LPs take, allowing them to be as risky or safe as they want with their investment.
• Please read the full article to learn everything you need to know about liquidity mining.

In return, you can earn an annual percentage yield in the range of double-digit or even triple-digit percentages. Liquidity mining is an excellent means to earning passive income for crypto assets that could have otherwise been hodled without the extra benefits. By participating as a liquidity provider, a crypto investor helps in the growth of the nascent Decentralized Finance marketplace while also earning some returns. Participating in these liquidity pools is very simple as it involves depositing your assets into a common pool called a liquidity pool. The process is similar to sending cryptocurrency from one wallet to another.

On crypto exchanges, they are usually the users themselves, who place orders to buy and sell. In other words, trading on crypto exchanges is person-to-person or P2P trading. You may have heard of it – Binance has a separate section for P2P trading. This is because liquidity pools are crucial parts of the DeFi ecosystem, especially for DEXs, as they provide liquidity, speed, and convenience. On the platform, there are seven various pools, each with a unique ERC-20 pool pair.

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The liquidity mining protocol gives users a Liquidity Provider Token in exchange for the trading pair. Liquidity mining, as we’ve seen, involves providing liquidity in exchange for “mining” rewards. The trader will pay a fee to the protocol, of which you will receive a portion in exchange for supplying your assets. DeversiFi is one of the leading liquidity pools that are famous for being quick and noticeable. Through the use of a layer 2 scaling engine, it provides the highest TPS, or transaction per second.

A liquidity pool is usually composed of two tokens that create a market for anyone wishing to exchange between the two. Some protocols, like Balancer, also offer multiple crypto asset pools, though this is not a common practice. The third issue with liquidity mining is the possibility of rug pulls, one among many crypto scams.

What Is Liquidity Mining: How to Profit from a Decentralized Ecosystem

When you deposit tokens into a liquidity pool and its price changes a few days later, the amount of money lost due to that change is your impermanent loss. Balancer liquidity mining includes supplying capital to liquidity pools in this platform. what is liquidity mining You’ll receive BAL tokens as a result of liquidity providing in Balancer. Decentralized finance is a new fintech application that seeks to disrupt traditional financial markets using decentralized networks such as blockchains.

The bank needs your money to grow its business, start new projects and invest in large-scale projects. Without people’s money, no bank would be able to do any of those things. On the other hand, the investor lends their money to the bank and receives interest.

Yield Farming vs. Staking vs. Liquidity Mining

This technique is also relatively simple to implement, making it excellent for novices. Now it’s finally time to select the amount of Ethereum you want to lock up, which is automatically matched by some Tether tokens. Both tokens must be in your wallet, and the Tether to Ethereum ratio varies across the different fee tiers. As the DeFi sector has been becoming more prominent, the popularity of liquidity mining has been growing respectively.

Liquidity mining is the act of lending your cryptocurrencies to a cryptocurrency platform or a DeFi protocol in exchange for rewards. The reward, often in the form of the platform’s native token, can then be reinvested for higher yields or sold. In essence, it is pretty much like putting your money in the bank and receiving interest. Therefore, when you do liquidity mining, you lend your liquidity to mine (i.e., generate) cryptocurrency. This kind of investment is one of the smartest ways to earn passive income during a bear market.

AMMs offer token swapping that makes it possible to trade one token for another within one particular liquidity pool. When a user decides to conduct a trade, they are supposed to pay a certain fee. The AMM, then, collects the fees and provides them to each liquidity provider as a reward.

Which platforms support liquidity mining?

So, it brings us to liquidity mining, which is one of the common ways of yield farming. Liquidity mining is where investors aim to earn passive income through supplying liquidity to decentralized exchanges (DEX’s) DeFi protocols. Once you convert your assets into LP tokens and deposit them into the liquidity pool, you are not able to trade them during the liquidity mining period. You will have to withdraw your LP tokens first then exchange them for the desired assets and after that you will be able to trade your assets without any limitation.

One needs to check the level of decentralization provided by a certain platform they are opting for. To do this, examine the project parameters, such as the number of liquidity suppliers, the total value locked , and the available liquidity. As well as this, Uniswap has its own native token called UNI, which entitles its owners to governance rights.

Is liquidity mining a long-term investment?

And the users themselves give them such rights, so when investing, always read the agreement carefully. However, this does not mean that the exchange can not interfere with the trading process. For example, if the plan is to open large short positions and turn the market around. In this way, you can manipulate the market, make profits by betting on the fall of rates, and raise revenue through commissions. But this is a dirty game, and legal platforms do not normally resort to this. Understanding the liquidity mining mechanism is important to understand what liquidity is and how it works.

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These tokens will facilitate low-friction trades between anonymous crypto holders. In other words, USDC/ETH is not only a token pair but a liquidity pool. A decentralized exchange like Uniswap offers dozens of such liquidity pools for various token pairs. If you had already heard of liquidity mining and even participated before it became mainstream, you are sure to be aware of how high interest rates were, back in the day. Some places, like Binance, offered a remuneration of between 50% and 100% per annum, and some other platforms offered up to several thousand percent. Even with a fair distribution of governance tokens, this system is still prone to inequality as a few large investors are capable of usurping the governance role.

In many cases, traders depend too much on the centralized exchange staff. Level of Decentralization – you need to find whether there is any risk of centralization from one or a few parties within the community. To do this, check the project metrics, including the number of liquidity providers, total value locked , and available liquidity. If you’re technically inclined, you can also audit the protocol’s source code by checking its GitHub repository. This leads to a more inclusive model where even the small investors get to contribute to the development of a marketplace. Earning passive income is one of the best ways to invest in cryptocurrencies, and there are several ways to do that, including staking your assets, lending them, and yield farming in DeFi platforms.

Higher yields are usually attached to pairings that involve smaller crypto projects with short operating histories and limited market caps. Bugs in the DEX system’s smart contracts could also undermine or erase your gains, and significant price changes in one or both of the crypto pairing’s components could also hurt your returns. So let’s select the middling fee tier of 0.3%, as most Ethereum-Tether liquidity miners do on Uniswap. That usually gives you an APR in the range of 80% to 90%, although the exact value varies over time. What actually happens is that the group of liquidity miners gets to share the fees collected from traders on the DEX, and the shared haul grows larger as trading volumes increase. Therefore, a smaller fee can work out to a larger payout if that particular tier happens to be incredibly active on the Uniswap trading platform.

Wrapped tokens are assets that represent a tokenized version of another crypto asset. Losses are only realized if the user decides to withdraw his liquidity. Therefore, it is possible to avoid IL if the market returns to the original price. If that does not happen, LPs are forced to withdraw liquidity and realize their IL. In the case of Uniswap, and all DEXs who use the same AMM model, crypto holders must provide equal portions of tokens . If we have 4 ETH tokens (where each is priced $2,500) we have a total of $10,000.

This is when a user either locks in their USDC or ETH funds into the liquidity pool. Then, just like Citadel Securities makes a cut from its spreads, users get a cut whenever people tap into those pools to swap tokens. In other words, they become liquidity providers engaged in liquidity mining. DEX – this is a short form for decentralized exchange, which is a platform that runs autonomously without direct intervention from a centralized party such as a company. Dexes are trading platforms to which liquidity providers contribute their digital assets. Yield farming is a broad categorization for all methods used by investors to earn passive income for lending out their cryptocurrencies.

The one who provides the liquidity is often left with the worse performing currency of the two. The Swiss Federal Institute of Technology (ETH Zürich) published a paper about liquidity mining. They found out that the average miner makes around 0% gains at the end of the year – due to impermanent loss. What their studies have shown is that mining with stable coin pairs is the safest and the most profitable way to generate a steady income out of liquidity mining. We also avoid pairs with stablecoins that have a questionable reputation – such as Tether.