Liquidity mining is a distinctive method to simultaneously generate passive income and provide liquidity to a platform. It involves low risk and requires only minimal effort. The challenges associated with liquidity mining need to be mentioned here as well which can be listed as the impermanent loss and exchange hacks.
Here you can read more details about liquidity mining, the advantages of liquidity mining, the risks associated with liquidity mining, how to start liquidity mining, and more. So, start reading y’all.
What Is Liquidity Mining?
Liquidity mining was a service that gained popularity during the primary DeFi boom which happened in 2020 and 2021. It received a demand from those who were in need of DeFi products and also the developers who were attempting to build advanced DeFi products.
It is a De-Fi mechanism where you can provide your crypto token holdings to DEXz. Upon this, you will receive liquidity pool tokens (LP tokens) in return. These LP tokens that you receive are used to calculate a reward.
The reward will be according to the total fees accumulated in the liquidity pool. This total fee is further divided among all those who have an LP token. If you need to borrow funds, you can borrow the fund amount from the pools with interest.
You can exchange your LP taken for the asset that you have inside the liquidity pool. You will have to pay fees based on the frequency of you using the pool to swap tokens. The most popular token pairs generate more fees for the liquidity providers.
Here, we have to mention the trade-off between the popularity of a liquidity pool and the liquidity provided. The small liquidity pools with a smaller number of liquidity providers and not-so-popular ones produce a high fee. At the same time, the popular pool with a high number of liquidity providers and really popular token paits provide small fees.
Liquidity Mining: Benefits
- Passive Income – It can be seen as a way to generate passive income. You do not need to invest much time and effort in liquidity mining to generate income from it. All you need to do is to provide liquidity to the exchange.
- Low Risk – In liquidity mining, you do not have to hold any certain number of tokens to be eligible for the rewards. There is an option to short or hedge your rewards.
- Investment Risk – It does not mandate you to invest in graphic cards and equipment and hence the investment risk is nominal. You can make money without any potential money loss.
- Public Exposure – Taking part in liquidity mining gives you an opportunity to expose your asset before the market. This has the potential to hike the asset’s exposure in the market and may also make the asset a widely traded one.
Liquidity Mining: Potential Risks
Now you know that liquidity mining does not require a massive effort from your side and involves only low-risk factors. Let us look deep into the risk factors associated with liquidity mining.
- Impermanent Loss
One of the prominent risks associated with liquidity mining is impermanent loss. It is the value drop that happens to the tokens after the deposit. The value of the tokens may drop to a lower value after some time you deposit it
- DEX Expolits
All the LP tokens are locked in the pool when you provide them for liquidity. The locked LP tones are controlled by the smart contract of the pool. In case, this smart contract gets hacked, the hacker gains access to all the locked assets.
- Rug Pulls
A rug pull is a kind of fraud where you will face loss. This happens when the liquidity pool creators and the DeFi developers or both of them decide to close the pool all of a sudden and retrieve the liquidity.
How Can I Start Liquidity Mining?
You may have probably thought of how to start liquidity mining. Here we have the basics that everyone needs to know before beginning liquidity mining:
- Visit a reputable DEX on a decentralized blockchain
- Connect your crypto wallet to the platform
- Select to add liquidity
- Choose the token pair
- Add the token pair in the right proportion
