Liquidity mining is when crypto holders lend their assets to a decentralized exchange in other to gain some rewards. Here, participants supply cryptocurrencies into liquidity pools for a particular exchange, and in return, they get rewarded with tokens and fees based on the amount of crypto they supplied to the pool.
This kind of pool usually consists of liquidity in form of tokens or coins, and they can only be accessed by Decentralized Exchanges (DEXs). Every liquidity provider is rewarded based on their total contribution to the pool.
Key Terms to Note in Liquidity Mining
• Decentralized exchanges
These are certain crypto exchanges that allow transactions to happen between two individuals without the need for any intermediary in form of a bank or other financial institutions. This type of exchange is not owned by one body, and it is usually managed by smart contracts and algorithms.
• Liquidity pools
This type of pool gives crypto holders the chance to lock their assets in the form of tokens and then supply them to decentralized exchanges. The exchange can do anything with the assets. It can be traded by the people on the platform or used for other purposes. However, once the crypto holder supplies their assets to the liquidity pool, they are eligible to receive their tokens right away.
When a trade happens on such an exchange, the transaction fee is distributed by all the liquidity providers, and the process is solely governed by smart contracts.
This is a passive mode of earning income for crypto holders. It allows them to utilize their existing assets to make quick gains rather than leaving them in cold storages doing nothing. Here, the assets gotten from providers are supplied to a decentralized exchange, and fees gotten from transactions of the platform are shared among the providers based on the amount of liquidity they provided the pool.
Benefits of liquidity mining
Now that you have a good understanding of what liquidity is, let’s take a look at the primary benefits of DeFi liquidity mining. They are:
- Potential for high yields
- Distribution of governance and native tokens
- Low barrier to entry
- Nurtures a trusting and loyal community
Despite the benefits of liquidity mining, there are also some risks you need to be aware of before you engage in it. Having a clear understanding of these risks can help you reduce the chance of falling into them.
Although liquidity mining as an investment looks simple and very easy, making it an ideal investment strategy for beginners. But the truth is that it is not the right fit for everyone. It can also come with a high risk that sometimes makes it not to be worth it.so, before you conclude if it’s right for you or not, make sure you have weighed the pros and cons of the strategy.
However, one interesting thing about liquidity mining is that the amount of gain you see from it depends on the amount of risks you are willing to take. That means you can be as risky or as safe with your investment. You are simply in full control here. So, if you are buying into this, it is advisable that you start small. Start with small investments and gradually move to bigger ones.
At the same time, don’t forget that it is possible for hackers to also have access to the project you are investing in, which could cause you to lose all of your investment. It can also happen when a rug-pull fraud happens. So, as you are putting your eyes on the strategy to earn some money, be mindful of the downside and carefully prepare an escape strategy for it.
While liquidity mining is somewhat new to the crypto space, it looks as though it is here to stay. If you have been looking everywhere for a sound investment strategy to boost your portfolio in 2022 and beyond, you might want to consider liquidity mining.
Lastly, always do your own research before jumping on any investment.