On the other hand, 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. Interestingly, the mining rewards are derived directly from the incentives for liquidity provision on the platform. Liquidity mining is necessary because a DEX needs liquidity to allow trading between different token pairs.

Liquidity mining explained

This increased liquidity also helps to stabilize the market, reducing volatility and creating a more stable environment for traders. LPs earn rewards in the form of the protocol’s native tokens, such as UNI, COMP, or SUSHI, depending on the protocol. The tokens are distributed to LPs in proportion to their contribution to the liquidity pool. For example, if an LP contributes 10% of the total liquidity pool, they will receive 10% of the rewards. Staking involves locking up your assets on a blockchain network to secure it and earn rewards.

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Of course, if the token you placed in a liquidity pool drops in value, you could wait for an increase in value before withdrawing it from the liquidity pool. The concept of a liquidity mining pool developed equal opportunities for institutional as well as low-capital investors. Discover how to securely purchase cryptocurrency like Bitcoin with a Co-Operative Bank account. The concept of liquidity mining should not be mistaken for that of Bitcoin or PoW coins mining. Usually, crypto noobs tend to use the word “mining” which does not give specifications as to what kind of mining they are referring to. Hisham Khan comes from a decade-long background in managing and building robust and innovative financial and enterprise technology.

Liquidity mining explained

In exchange for liquidity, the user earns a reward from the exchange or dApp in cryptocurrency made possible by charging a small fee from users. The blockchain space is still growing and whether liquidity mining will prove to be a worthwhile long-term crypto investment strategy remains to be seen. Decentralized finance is a new fintech application that seeks to disrupt traditional financial markets using decentralized networks such as blockchains. DeFi platforms work by eliminating centralized financial intermediaries allowing market participants to interact in a peer-to-peer (P2P) manner. You can lose money during liquidity mining if the crypto price of the token goes down, and you withdraw.

What is DeFi?

Therefore, we can claim 0.8% of the accrued fees when withdrawing our investment from the pool. At some point, users will spot this opportunity and will start swapping strawberries for lemons as they have become incredibly cheap. Often, arbitrage bots are good at maintaining a healthy balance for open markets. We can rebalance the pool by adjusting the price between lemons and strawberries.

Liquidity mining explained

Delegates are elected by the community, and those with the most staked coins have a better chance of being elected. Users who delegate their coins to a delegate will earn rewards based on the delegate’s performance. Yield farming is a popular decentralized financial instrument in DeFi that https://www.xcritical.com/ yields capital by extracting value from providing liquidity to decentralized exchanges. DeFi (decentralized finance) apps use the liquidity mining term to describe the process when users lend crypto to support liquidity of decentralized financial institutions and take rewards for it.

Price discovery promotion

Just as importantly, given that intermediaries are removed from the process, users manage to gain some additional benefits not present in traditional finance. For instance, DeFi lending protocols provide higher interest rates for deposits and even lower fees, along with more favorable terms on loans. Apart from LP tokens, liquidity farming protocols could also reward liquidity miners with governance tokens. While liquidity farming or mining presents many favorable prospects for growth of DEXs and DeFi, it also has many setbacks.

Liquidity mining explained

The user is encouraged to deposit more and more into the wallet to increase returns, but will eventually find that they can neither withdraw their crypto nor actually cash out any alleged rewards. Yearn Finance provides its services autonomously and removes the necessity to engage financial intermediaries such as financial institutions or custodians. https://www.xcritical.com/blog/what-is-liquidity-mining/ The protocol is maintained by several independent developers and is managed primarily by YFI holders, making it possible for all of Yearn’s features to be implemented in a decentralized way. While no one can predict the future with absolute certainty, industry experts believe that liquidity mining will likely remain a lucrative option for investors.