What Is Yield Farming? The Rocket Fuel of DeFi, Explained

Due to the decentralized nature of the network, anyone can build their own liquidity pool based on fraudulent information. As a result, attackers will be able to steal tokens while users are unaware of the artificiality. The worst-case scenario is that the attackers gain access to the pool and manipulate the protocol to their advantage. The Balancer protocol has been gaining momentum and stimulating the growth of the entire DeFi ecosystem. Its key mission is to introduce an elaborate financial protocol that offers programmable liquidity in a flexible and decentralized way as well as instant on-chain swaps with moderate gas costs. The win-win-win outcome in liquidity protocols – all parties within a DeFi marketplace benefit from this interaction model.

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. Information asymmetry – the biggest challenge for investors within decentralized networks with open protocols such as DeFi marketplaces is that information is not fairly distributed to the public.

liquidity mining definition

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. Therefore, lending 4 ETH means that we also have to provide 10,000 USDT (valued at $1 per token). Ok, now that we understand what impermanent loss is, let’s see how it can take away LPs profit as the value of one asset increases in relation to the other. Whilst each of these terms implies that a user earns compensation by making their assets available for a limited time in order to support an economic function, the underlying nature of these terms differ.

What is the Process of Liquidity Mining?

Start learning more about liquidity farming on DeFi protocols and the best ways to capitalize on the available prospects. Launched in 2020, Yearn Finance (also known as yearn.finance) is represented as a set of protocols that rely on the Ethereum blockchain. This protocol allows users to boost passive earnings on their crypto assets by using the trading and lending services provided by the platform. Liquidity mining projects that focus on fair decentralization normally look for ways to reward their active community members. Oftentimes, all users who decide to join the platform are given governance tokens. As a result, developers ensure decentralization by providing tokens in a way that doesn’t require a token sale or market listing.

Top 5 Most Reliable Forex Brokers of 2022The Forex market is the world’s largest and most liquid financial marketplace, which allows traders to buy and sell currencies 24 hours a day. 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. Security – blockchain networks and protocols are hacked on a fairly regular basis, and you want to minimize the risk of losing your investment by choosing a secure platform. For whichever DeFi platform you are considering, check its history for security hacks. Ensure that the platform regularly undertakes a third-party independent security audit. Finally, consider the age of the platform and the identity of the core developers.

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The purpose of rewarding you for doing so is to ensure the present and future of the technology you’re pursuing. In POS Staking, you make some of your assets available to the network in exchange for a specified quantity of reward coins for the value you create . The treasury would earn fees for this service, and the fees could be distributed via a debenture bond or similar financial instrument. As the new year gets underway, projects working on solving this quandary are some of the most popular among traders and investors.

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  • Therefore, if you don’t want to lose profits, you should constantly monitor the market, especially impermanent loss.
  • Anyone, anywhere at any time can participate in Liquidity Mining and reap the benefits thereof.
  • The lenders thus receive additional cryptocurrencies for using the service, which is freely traded on the market.
  • Compared to traditional loans, flash loans empower users to borrow an unlimited amount of funds without requiring any collateral, on the condition that users pay it back within the same transaction.

Yearn, where users add their funds to pools that are then used to generate yield. As anyone can be a liquidity provider, AMMs have made market making more accessible. Staking can be used to support various encryption and DeFi protocols in various ways. A shift from Proof of Work to a Proof of Stake is in progress in the Ethereum 2.0 paradigm.

Frequently Asked Questions on Liquidity Mining

This is similar to Bitcoin mining, where miners are rewarded with a certain number of BTC per block. DeFiChain is a hybrid proof-of-work & proof-of-stake blockchain where the number of coins per block gets smaller and smaller in the long run. In accounting and financial analysis, a company’s liquidity is a measure of how easily it can meet its short-term financial obligations.

liquidity mining definition

If you want to make a significant investment, your reward will be proportional to your contribution. The same will work if you try liquidity mining before committing to it full-time. That said, distributing governance tokens might make things a lot less risky for startups, at least with regard to the money cops. “Yield farmers are extremely creative. They find ways to ‘stack’ yields and even earn multiple governance tokens at once,” said Spencer Noon of DTC Capital. On Uniswap, there is at least one market pair for almost any token on Ethereum.

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To work with liquidity mining, the miner does not need special equipment —it is enough to choose a project that will generate income and choose a strategy for work. The following steps will guide you through the liquidity generation process. Hisham Khan comes from a decade-long background in managing and building robust and innovative financial and enterprise technology.

These smart contracts power almost every part of DeFi, and they will most likely continue to do so. Another emerging DeFi sector is insurance against smart what is liquidity mining contract risk. To understand how liquidity pools are different, let’s look at the fundamental building block of electronic trading – the order book.

Liquidity mining is a type of passive income that allows crypto holders to profit from their present assets instead of holding them in cold storage. In exchange for a proportional distribution of trading fees to each liquidity provider, assets are loaned to a decentralised exchange. Individuals who supply liquidity are also more https://xcritical.com/ likely to use the system and keep tokens after investing in their digital holdings. The advantages of liquidity mining go beyond the money you earn as a liquidity provider. You will continue to obtain more benefits if you continue to follow the protocol. To enable trading on decentralized platforms, they must provide liquidity.

In addition, with automated market makers such as Uniswap, large price changes can occur at the execution of a trade. A Staking Reward Program may pay out rewards to users for providing liquidity to DEX pools above and beyond the rewards already paid by a DEX. The currently most well-known provider for decentralized trading and liquidity mining is Uniswap. Token swaps then take place now between the wallet and the respective pool. You quickly earn significant passive income with a high annual interest rate and regular giveaways.

Simply put, the order book is a collection of the currently open orders for a given market. A liquidity pool is basically funds thrown together in a big digital pile. But what can you do with this pile in a permissionless environment, where anyone can add liquidity to it? It is the process of depositing or lending specific token assets with the goal of giving liquidity to the product’s fund pool while also earning money. Liquidity mining is a passive income model with which investors utilize existing crypto assets to generate more cryptocurrencies on DeFi platforms. 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.

Binance is an illustration of an exchange which offers rewards to users who deposit their tokens on the exchange. Liquidity providers are incentivized in proportion to the amount of liquidity they supply to the liquidity pool. In traditional finance , brokerage houses and firms serve as market makers, providing purchase and sale solutions for investors. A mechanism or process in which participants supply cryptocurrencies into liquidity pools, and are rewarded with fees and tokens based on their share of the total pool liquidity. These pools consist of liquidity in pairs of coins or tokens, accessible viaDecentralized Exchanges .


The use of blockchain and cryptocurrencies has exploded in recent years. While the most common crypto investment approach is buying and keeping cryptocurrencies until their value rises, there are various other ways to create passive income. Liquidity mining is one such approach, which takes advantage of the massive buzz around decentralized finance while letting investors profit from their holdings. Another example is Balancer that offers pools with arbitrary weights outside of the standard 50/50 weighted model. This can also reduce the impact of impermanent loss depending on the weights in the pool. The higher the weight of a token in the pool, the lesser the difference between holding the token and providing liquidity in the token becomes.

Bekannte Defi Plattformen für Liquidity Mining

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. If the exchange supports OTC trading, then the liquidity provider here is either the exchange itself or other institutional investors. Liquidity mining is a network interaction method in the bitcoin ecosystem that contributes to a liquidity pool. As a result of your donation, the specific liquidity pool to which liquidity was donated will pay you a reward.

Ren, Curve and Synthetix have also teamed up to promote a liquidity pool on Curve. In Traditional Finance, market makers such as brokerage houses or firms provide trading services for investors in an effort to keep financial markets liquid. These market makers take on the risk of holding assets to provide liquidity to the market – which is why they are compensated while also earning a profit through the spread between the asset bid and offer price. 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.

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. Compound was the first to introduce liquidity mining when it began rewarding users with COMP, its governance token. This additional stream of income for liquidity providers can help cover some or all of the temporary loss risk they take on.