What Is Liquidity Mining? A Beginners Guide to Decentralized Finance DeFi

With the help of liquidity farming programs, a protocol could develop a community that trusts and supports the new projects on the platform. 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.

The win-win-win outcome in liquidity protocols – all parties within a DeFi marketplace benefit from this interaction model. 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. A liquidity pool typically consists of a trading pair such as ETH/USDT. As a liquidity miner , an investor could opt to deposit either asset into the pool.

What are tokens?

This is explained in detail in the next part of this DEX explanation series. Because of the arbitrage already mentioned, however, this always balances out in the long term and this risk is only a temporary, short-term one. In the first two parts of this series around decentralized Exchanges, we looked at 10 criteria to evaluate a DEX as well as the liquidity mining and exchange function on a decentralized exchange. We create tools, assets, and ecosystems to seamlessly merge real-life and digital worlds within your Metaverse projects.It could be a multi-layer virtual space or a unique artwork item.

Liquidity mining explained

Liquidity mining is becoming increasingly popular amongst crypto investors for a good reason. Vote on crucial changes to the protocols, such as fee share ratio and user experience, among others. As this sector gets more robust, its architects will come up with ever more robust ways to optimize liquidity incentives in increasingly refined ways.

What is liquidity mining?

In DeFi, you can borrow money without anyone even asking for your name. After you sign up and connect your first exchange account, you’ll deploy an investment-maximizing strategy in as few as 5-minutes. Each day Shrimpy executes over 200,000 automated trades on https://xcritical.com/ behalf of our investor community. In the long term, the ratio thus automatically balances itself out and always adapts to the real, independently determined value of the free market. Please check your credentials and twitter username in the twitter settings.

It allows users to efficiently swap between ERC-20 tokens with no required order book. Given that the Uniswap protocol is totally decentralized, it doesn’t include any listing process either. Any ERC-20 token can be launched on the condition that there’s an available liquidity pool for traders. Curve was introduced in 2020 as an attempt to offer an advanced automated market maker exchange with low fees for traders and substantial savings for liquidity providers. Curve focuses mainly on stablecoins, therefore granting investors an opportunity to evade more volatile crypto assets and earn high interest rates from their lending protocols. According to DeFi Llama, Curve is the largest protocol with TVL of more than $20 billion.

Liquidity mining explained

Other than its consensus mechanism, the BSC blockchain is almost identical to Ethereum and can even be accessed through the popular MetaMask Ethereum wallet. Compounder Finance is not related to another well-known DeFi protocol called Compound Finance. Finbold is compensated if you access certain of the products or services offered by eToro USA LLC and/or eToro USA Securities Inc. Any testimonials contained in this communication may not be representative of the experience of other eToro customers and such testimonials are not guarantees of future performance or success. Sign up for Valid Points, our weekly newsletter breaking down Ethereum’s evolution and its impact on crypto markets. Some fresh fields may open and some may soon bear much less luscious fruit.

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If an asset within the LP of choice loses or gains too much value after being deposited, the user is at risk of not profiting or even losing money. For example, Ethereum can double in value within 5 days but the fees granted while farming it will not even cover half of what one would have made by HODLing. In the case of Uniswap, and all DEXs who use the same AMM model, crypto holders must provide equal portions of tokens .

Liquidity mining explained

We could see token holders greenlighting more ways for investors to profit from DeFi niches. For example, forms of profit-sharing that reward certain kinds of behavior. It is a fair bet many of the more well-known DeFi projects will announce some kind of coin that can be mined by providing liquidity.

The risks in liquidity mining

The funding issue with ICOs is that tokens are not distributed equally. So one way to even the playing field is by investing through a liquidity mining pool. Even if liquidity farming makes token distribution fairer, the concept of ICO rewards still works on the principle of the higher the stake, the higher the reward. Liquidity pools also can be vulnerable to a unique type of fraud known as a “rug pull.” Scammers set up a new cryptocurrency and push capital into the coin through DEX services.

Liquidity mining explained

In order to transact on Aave, lenders are required to deposit their funds into liquidity pools so that other users can then borrow from these pools. In each pool, assets are normally set aside as reserves with a view to hedging against volatility and ensuring that lenders will be able to withdraw their funds once they wish to exit the protocol. The two key concepts that govern the working of AMM are liquidity providers and liquidity pools. Liquidity providers deposit their crypto assets in the liquidity pools of the marketplaces to facilitate their token swapping, lending, and borrowing functions. Liquidity mining profitability emerge largely with a win-win situation for decentralized exchange platforms and liquidity providers.


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. Elon starts tweeting about DOGE and it does a 100x while ETH doing a healthy 2x meanwhile. You’re thinking you’re $500 in DOGE turned into $50’000 and your $500 in ETH turned into $1000.

DeFi protocols are still in the early stages of development, and there are numerous security loopholes that need to be addressed. While you certainly can, and we’re seeing that pool staking is much more rewarding than solo staking, it isn’t a must. A single holder will likely fail to meet the liquidity demands for the exchange. Let’s say you want to tap into a liquidity pool on Uniswap, which is the oldest and largest DEX.

  • So, fair decentralization protocols are more likely to distribute native tokens equally among early community members and active users.
  • Investors should perform their due diligence before joining a liquidity mining pool.
  • To do this, check the project metrics, including the number of liquidity providers, total value locked , and available liquidity.
  • Before liquidity mining existed, traders would hold their tokens and crypto on hardware wallets or exchanges.
  • Some fresh fields may open and some may soon bear much less luscious fruit.
  • In decentralized finance, liquidity pools have become the go-to option of choice, providing constant, automated liquidity for decentralized trading platforms.

Yes, liquidity mining is an important part of the yield farming strategy. The automated type of yield farming provides a significant amount of the DEX trading volume that drives liquidity rewards higher. Uniswap is a decentralized exchange what is liquidity mining protocol that runs on the Ethereum blockchain. It doesn’t require any intermediaries or other centralized parties to carry out trades. Uniswap mainly relies on the model that allows liquidity providers to create liquidity pools.

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The Automated Market Maker 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. In order to mitigate impermanent loss, it’s important to create a strategy before pooling your tokens so you know which price scenarios give the best opportunity to pull your LP tokens to minimize potential loss. I’ll probably make a more in depth post in the future on strategies for liquidity providing but this should provide you with plenty of knowledge to confidently get started. UniSwap is arguably the largest decentralized crypto exchange with a current trading volume of more than $800 Billion. The platform supports Ethereum and ERC-20 tokens (only Ethereum-hosted assets).

It was introduced by IDEX back in 2017, fine-tuned by Synthetix and decentralized oracle provider Chainlink in 2019, and started being used at full throttle after Compound and Uniswap popularized it in June 2020. As of today, it’s been adopted by several protocols and is considered to be a smart and efficient way of distributing tokens. The majority of these protocols are decentralized and allow almost anyone to become part of the liquidity mining process. The most apparent advantage of liquidity pools is that traders wishing to use decentralized markets are ensured a near-continuous stream of liquidity. By being a liquidity supplier and collecting trading commissions, they also provide the ability to benefit from cryptocurrency holdings. The algorithm that decides an asset’s price could fail, slippage due to large orders, failure of a smart contract, and more.

Did liquidity mining start with COMP?

Users deposit their crypto assets in the platform in exchange for rewards. These incentives can take the form of getting a proportion of each trader’s fees or incentives in the form of tokens . As most ecosystems provide their communities with a governance model, additional benefits such as voting rights can further incentivize liquidity mining.

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This is called an impermanent loss since it can only be realized if the miner decides to withdraw the tokens with depressed prices. Sometimes this unrealized loss can be offset by the gains from the LP rewards; however, crypto assets are highly volatile with wild price movements. Liquidity mining is simply a passive income method that helps crypto holders profit by utilizing their existing assets, rather than leaving them inactive in cold storage. Assets are lent to a decentralized exchange and in return, the platform distributes fees earned from trading to each liquidity provider proportionally. 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.

One of these reasons is the possibility to earn considerable amounts of passive income from cryptocurrencies in a variety of ways, one of which is liquidity mining. Liquidity mining is similar to providing liquidity in the fact that both involve providing liquidity to a DEX. However, the process of liquidity farming or mining involves LP tokens or liquidity provider tokens you get for offering liquidity. Now, you can use the LP tokens in mining programs for earning rewards. Interestingly, the mining rewards are derived directly from the incentives for liquidity provision on the platform.

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