Passive Earnings from DeFi Liquidity Mining
If you’ve invested your money in digital assets and don’t want to just leave them sitting in a wallet, you’re in luck! The CeFi and DeFi markets have plenty of tools available to help you earn passive income, including staking and yield farming. Another option to consider is liquidity mining.
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We have previously introduced our readers to various types of passive income, including staking, yield farming, and dual-currency investments. Now, it is time to get acquainted with liquidity mining.
Understanding liquidity mining
Liquidity mining is a DeFi market product that is specifically associated with decentralized exchanges (DEX). It closely resembles yield farming, but it has its own distinguishing features. Individuals who supply assets to liquidity pools are designated as liquidity providers (LP).
To put it plainly, this is a tool for generating passive income. It offers the opportunity to allocate a portion of your idle assets (coins or tokens) to liquidity pools (LP) on DEXs. By depositing your assets into these liquidity pools for a certain period of time, the investor receives a reward, including interest, a portion of trading fees, tokens of one of the assets in the currency pair (referred to as “LP tokens”), or governance tokens of the DEX or protocol.
Decentralized exchanges require a significant amount of liquidity to facilitate trades between various pairs of digital assets. The incentivization strategy linked to yield farming or liquidity mining motivates users to contribute as many different assets as possible to enhance liquidity on the DEX. As a result, nearly all liquidity pools with different trading pairs require users to deposit two assets instead of just one.
The perks of being a liquidity provider
Apart from the financial facet, a pivotal component within the DeFi ecosystem is decentralization, which attracts investors to DEX. The developers of DEXs and protocols aim to draw the widest possible audience into the DeFi market by facilitating a seamless migration from CeFi, thereby increasing the fraction of decentralized community projects.
Decentralized exchanges and DeFi projects empower their communities and liquidity providers (LP) to take the reins of protocol development and trading platform management. These projects prefer a collaborative management approach that promotes inclusivity and provides all users with the right to participate in voting processes. Holding governance tokens of a platform is key to unlocking voting rights, and developers are committed to ensuring a fair distribution of these tokens among all participants to preserve the core values of decentralization.
Governance tokens play a crucial role in liquidity mining as they provide non-financial benefits that encourage user loyalty. For this reason, many protocols and DeFi platforms incentivize liquidity providers with not only high yield rates but also governance tokens, the quantity of which is proportional to the amount of LP liquidity supplied to the pool.
Liquidity providers are granted the privilege of directly impacting the governance of decentralized exchange platforms. Their voting power during decision-making processes increases proportionally to the liquidity they contribute to the pool. The symbiosis of financial and non-financial incentives makes liquidity mining a captivating instrument for numerous crypto enthusiasts aspiring to participate directly in the progress of the DeFi market sector.
Liquidity mining: pros and cons
The benefits of this instrument include:
Passive income. Liquidity mining is another avenue for generating passive income, on par with staking or yield farming.
Win-win formula. This collaborative format benefits all participants involved in the DeFi market. Platforms receive a positive inflow of liquidity and a boost in the number of new users, while LPs are rewarded for providing their assets to liquidity pools and earn the privilege of participating in the development of platforms and the market holistically.
Low entry threshold. Investors with modest capital have the opportunity to participate in liquidity mining, as most platforms accept deposits even in small amounts.
The concept of crypto-democracy and community management. Every individual who provides liquidity (regardless of the amount) is rewarded with governance tokens, granting them a voice to influence the further development of the project.
Alas, just like in any investment domain, liquidity mining has its own risks:
Financial loss. There is a risk of financial damage if the value of assets locked in the pool decreases below the entry price.
Exit scam. Creators of a DeFi platform may collect a large amount of investments and then disappear with the money, leaving investors with nothing.
Security system vulnerabilities. Since most of the smart contracts used in liquidity mining are code, they can contain bugs that could potentially allow for successful hacking attempts. Technical flaws and weak security systems can allow hackers to steal funds from investors, withdraw them from DeFi protocols, and transfer them to external wallets.
Final words
Now that you have acquired a comprehensive understanding of liquidity mining, along with its merits and potential drawbacks, you are well-equipped to embark on this financial venture. If you choose the right platform and currency pair, you can use this tool to consistently earn profits and boost the returns on your investment portfolio. Plus, it's a great way to generate passive income.
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