2.7 k views

Liquidity Mining – Everything you Need to Know About It

In the world of DeFi, market-making is a critical component of growth. Without it, there is no new development. However, the current forms of generating liquidity are inefficient. Liquidity mining is the market’s solution to this problem. Specifically, liquidity mining creates a community-based, data-driven system to generate liquidity in the market. Miners receive rewards for providing liquidity to the sector.

The process requires depositing or lending designated blockchain assets. These systems employ a mining mechanism to provide liquidity for a product’s fund pool. Additionally, one trait all of these platforms share is that they allow users to earn interest for their participation. Specifically, You earn rewards for operating a market-making bot. This bot maintains orders on an exchange order book. 

Similar to Proof-of-Work Mechanism

The actual term “Liquidity Mining” derives from the addition of the mining mechanism. This is similar to a proof-of-work mining system in that miner run open-source software on their computers and uses their scarce resources. In this case, it’s their inventory of crypto assets.

Unlike PoW blockchains like Bitcoin, users utilize more than just computational power. They also utilize their token inventory. This approach is more democratic because it doesn’t require expensive mining equipment. Importantly, liquidity miners receive rewards in a specific project’s native token. 

Governance Rights

There are also instances when they can receive the governance rights the token represents. Liquidity mining platforms can utilize various cross-chain capabilities. Some of these systems don’t require you to trade into the blockchain’s direct asset you desire to utilize. Features like atomic swaps make this possible today. As such, atomic swaps are popular in the DeFi sector.

The main point is that these tokens provide voting rights to the user. Each platform may have different minimum token volume requirements before these rights are accessible. Be sure to review your terms of service. Most platforms base their rewards on three main criteria.

Order Amount

The larger your order is, the more rewards you will earn. The goal here is to maintain a high level of participation from the average user. 

The Spread

The spread is the distance to the mid-price of your orders on the platform.

The Timeframe You Maintain Orders on the Order Book

The longer you maintain your order open, the more rewards you earn.

Currently, most governance tokens also serve a speculative purpose. Since the DeFi sector is just gaining momentum, investors buy these tokens with the hopes of reselling them for a higher value as the platform’s popularity grows. Some platforms will succeed. Sadly, most won’t. The difference between success and failure is often transparency.

What Problems Does Liquidity Mining Attempt to Fix?

Liquidity mining currently helps rectify a few areas of concern in the DeFi world. Specifically, it improves liquidity for new projects. Access to funding is vital to the cold start of a project. Unlike traditional industries, the DeFi industry lacks the self-built capital pool that start-ups require to achieve stable liquidity. Currently, exchanges and token issuers pay quantitative hedge funds millions to provide liquidity in the sector.

Liquidity mining uniquely resolves this problem. It allows regular users to provide the missing liquidity. Users lend out their crypto and earn interest. What makes it more advanced than previous yield farming strategies is that it creates user incentives through an interest rate mechanism.

These systems function similarly because the more a user lends, the more interest they earn. Consequently, the liquidity pool grows due to these actions. As the liquidity pool expands, the user’s profits grow as well. In this way, liquidity mining effectively links value islands in a decentralized dimension. This strategy accelerates the frequency of value exchange. The end goal is to promote price discovery.

How Does Liquidity Mining Work

Each Liquidity Mining platform differs slightly, but the basic functions remain the same. You lock up your crypto in a smart contract on the DeFi platform. These funds go to a lending pool. This pool is where people borrow from. You receive an interest in participating. It’s that simple. 

Benefits of Liquidity Mining

Many benefits of liquidity mining make it so popular. For one, regular users can earn a passive income without previous requirements. Most liquidity pools provide a frictionless onramp to the market. The platforms are easy to sign up for, and they don’t require any special equipment like traditional mining. Keenly, the best platforms allow you to start earning interest instantly. 

Risks of Liquidity Mining

There is also some risk that liquidity mining investors should be aware of. These risks span the gamut from technical risks to a market collapse. Mainly, computer errors or bugs are the biggest threat to the success of these platforms. In June of this year, miners from the platform Compound lost tens of thousands of dollars when they were accidentally liquidated. The culprit turned out to be an improper pledge rate setting.

Another major risk faced by liquidity mining participants is inventory risk. Sudden negative price movements can eat away at the platform’s inventory value. You can also have a scenario where a market maker acquires too large of a project stake. Users must remain vigilant in their market analysis to avoid these concerns. Invest at your own risk. 

History of Liquidity Mining

Liquidity Mining is still fairly new to the market. Compound launched “Liquidity Mining” on June 16 of this year. The feature was an instant success. Compound reported an increase in locked funds from approximately 180 million to 650 million in just 20 days. Additionally, user registration increased to over 6000 active lenders and borrowers. It was clear the market desired this solution.

A New Day is Here

Bitcoin live price
price change

Since then, the market has exploded. Every week new DeFi platforms enter the sector with more aggressive incentive programs. Today, anyone can earn a healthy ROI by lending out their crypto via these platforms. At this time, the key is to be cautious and DYOR to avoid major losses. 

Stay up to date with our latest articles

More posts

Why SolidProof Stands Out in the Blockchain Security Landscape

SolidProof - a registered security company from Germany - has announced the imminent release of an updated version of its SolidProof Automated Audit Tool (SAAT). This unique blockchain industry product supports decentralized finance (DeFi) growth, enabling projects to minimize security threats. An upgraded SolidProof App is also ready to roll out with new and exciting features, cementing SolidProof’s place in the top tier of blockchain security providers. Increased Challenges for DeFi Security Decentralized finance has evolved on top of blockchain…

Top 5 Crypto Audit & KYC Providers on Arbitrum

The days of unaudited projects, suspicious developers, and unverified investors running havoc in the crypto space are over. Today, the industry’s main actors agree that only complete transparency and security can help blockchain fulfill its latent potential. That’s why audit and KYC companies are central to building a safe and reliable Web3 environment for everyone. New projects can rely on crypto auditors to build better smart contract codes. Meanwhile, development teams can pass Know-Your-Customer (KYC) verification to ensure potential investors…

What Happens When a Stablecoin Loses Its Parity (Depegging)?

Have you heard of stablecoins, the digital currencies designed to maintain a stable value? Stablecoins have become increasingly popular, and many people consider them an attractive investment option. But what happens if a stablecoin loses its parity, and how does it impact investors?   Understanding the General Concept of Stablecoins Before discussing a stablecoin losing its parity, we first need to grasp how these tokens work. Stablecoins are cryptocurrencies tied to fiat currencies like the U.S. Dollar or Euro. This means…

How to Get Your Smart Contract Audited in 2023

To ensure the security of their smart contracts, companies are increasingly turning to third-party auditors. This is not surprising, considering smart contract auditing has become vital to blockchain development.  With smart contracts playing an ever-increasing role in the digital world, ensuring they are secure and reliable is essential. Today we’ll explain what to look for when choosing an auditor, how long the process takes, and what auditors examine. We will also outline the results of an audit and how to…

DeFi Scams – Most Common Scams in the DeFi Space

Defi scams are, unfortunately, all too common. This article looks at popular Defi scams, how they operate, and how to protect yourself. We'll also provide tips on what to do if somebody scammed you and how to report a scammer. Finally, we'll discuss the implications of DeFi scamming and present examples of successful prosecutions. What Are DeFi Scams, and How Do They Work? Decentralized Finance (DeFi) is a term that has gained enormous popularity over the years. DeFi is the…

Here are the Benefits of Auditing Your Smart Contract with SolidProof

Auditing a smart contract is vital to ensure that the code functions as intended. SolidProof offers a wide range of services to help with this process. In addition, the company guarantees a sound audit process and an experienced team of auditors.  Here are the benefits of auditing a smart contract with a reputable company such as SolidProof: A wide range of services: SolidProof offers a wide range of services to help with the audit process, including code review, security analysis,…

Smart Contracts Vulnerabilities Specific to The DeFi Space

As the financial world moves increasingly online, ensuring that all transactions run securely is becoming increasingly essential. One way this is possible is through the use of smart contracts.  Smart contracts are computer programs that automatically execute the terms of a contract. They provide a secure way to conduct transactions without relying on third-party intermediaries.  While smart contracts offer many advantages, they are also vulnerable to attack. In this blog, we will explore how attackers can exploit vulnerabilities in smart…

Real Yield: The Top DeFi Tokens for Generating Actual Revenue

This year’s brutal bear market has claimed a sizable batch of crypto startups and nascent coins. To weather the volatility, the long-term believers in decentralized finance (DeFi) are in search of one thing: “Real Yield.” The term has grown in popularity among those looking for hidden gems in the market for decentralized finance applications. But, more importantly, it marks an appetite for responsible crypto investment opportunities that can outlast a turbulent market cycle.  So what exactly is “real yield” in…

Get Top Notch Smart Contract Audit and KYC Services for your Crypto Project with Solidproof

Solidproof is one of the top auditors in the crypto industry, with an increasing offer of smart contract auditing, KYC, and marketing services. The German company has developed quickly since its inception in 2021, building a vast portfolio of prestigious and successful clients. The DeFi space is a nourishing environment for crypto and decentralized finance projects. However, it is also a breeding ground for scammers, multi-million hacks, fraud, and money laundering. Protocols running on faulty codes risk exposure to cybercriminal…

How Does KYC Work in the DeFi Space?

Decentralized finance (DeFi) has the potential to reach mainstream adoption and empower people worldwide financially. However, without regulations and identity control, it can easily become a platform for scams, fraud, and money laundering. The paradox is that by introducing stricter control on who can access DeFi products, the industry loses its "decentralization" factor. After all, this is what set it apart from traditional centralized finance (CeFi) in the first place. This is where KYC (Know Your Customer) standards come in…