If you are a crypto trader, you may have heard of the concept of liquidity mining but are not sure what it is or how it actually works. Some traders claim that they make great returns and passive income by draining their liquidity and in this article we will look at that.
We show what liquid mining actually is, how it works, explain the importance of liquidity pools and analyze the advantages and disadvantages of this concept.
What is Liquidity Mining?
Liquidity mining is a yield farming method performed with the help of an Automated Market Maker (AMM). An example of an AMM is Uniswap.
How it works: It activates a protocol that offers trades between traders and a liquidity pool. Liquidity providers maintain this liquidity pool, and in the case of a decentralized exchange (DeFi), traders provide liquidity themselves. It’s basically about using your wealth to work for you and make money. We willingly put our money into the pool, which then charges fees to other traders. Some of it comes back to you and earns you interest over time.
Yield Farming vs Staking vs Liquidity Mining
All of these actions have some common points and are interconnected. Staking, in its most general sense, means owning a specific cryptocurrency and earning rewards from it. Why are there rewards? Because when it comes to staking, each active member helps the network stay safe by providing a proof of stake for every transaction.
Yield farming is any method of investing money and earning interest – an annual percentage return (APY). This means that DeFi liquidity mining is a type of yield farming where you earn passive profit by providing liquidity to decentralized exchanges. If you’re still up for some regular mining, 2022 brought a slew of phone mining apps and we recommend taking a look at this guide, which details the best apps for mining crypto right now.
How does liquidity mining work?
We invest our crypto funds in the market maker to increase liquidity and we earn a share of the trading fees charged by other traders. The amount we earn depends on the part of the trading pool we provide and the total trading volume for that trading pair. For example, for a BTC and USDT pair, there is $1 million in liquidity, and your return here is 5% to 10% APY.
Keep in mind that these rewards are not fixed and the percentages are based on current trading volume statistics. As trading volume will change over time, your APY will be affected.
Liquidity Pools
Crypto liquidity mining pools are pools where traders can invest their assets to provide each other with liquidity, exchange currencies and earn interest. Liquidity accelerates transactions and each pool is secured by a smart contract.
advantages
Fair system with governance tokens
Anyone can participate and get government tokens. This gives them a say in the future of projects and the decisions the creators make. This is an inclusive and inclusive democratic system to be a part of.
The importance of DeFi
You probably know that DeFi revolutionized the market by bringing a symmetric, fair game for investors instead of an asymmetric, bank-centric relationship. For our topic, the most important thing that DeFi brought to traders was putting their crypto on exchanges, liquidity pools and other protocols and allowing traders to earn passive income.
Right now, DeFi is entering a new phase called 2.0, with thousands of new coin opportunities and improved technology. Here you can learn about some of the top new coins and connect with new DeFi 2.0 projects.
Low barrier
Anyone can participate, including small investors. No matter how small your contribution, you can be a part of the community and get decent rewards.
risks
Ephemeral Loss
This is an inherent feature of any AMM and occurs when the price of the coins in the trading pair changes. There is a ratio or balance between the coins in a pair and when that ratio is compromised, you as a trader suffer an inconsistent loss.
Why is this loss called impermanent? Because you only really lose money if you take your crypto funds out of the liquidity pool. Your total profit can be viewed as the total trading fees you have earned minus the temporary loss. You can use online calculators for this, which will show you your potential temporary losses based on how you think the coin would move. Also, volatility increases temporary loss; That’s why it’s always a good idea to have a stablecoin in your pair.
leverage
On some exchanges there is an opportunity to leverage when mining liquidity. By activating leverage, you increase your represented amount in the liquidity pool.
This can drastically increase your APY, but it also significantly increases your risk. Leverage creates a price of liquidity and increases volatility, which means that if the price falls sharply, all of your investments will be closed and you won’t have enough to cover the loss.
pull carpet
Rug pulling occurs when a coin creator backs out of the project and steals all investments. Unfortunately, this is not uncommon, so always make sure to invest in a legitimate and stable project.
Author: Sviatoslav Pinchuk, COO of TradeCrypto, is a crypto journalist who simply bought some BTC for personal use in 2014 and then forgot about it until 2017. He misclicked Etherium in 2017 and sold it in 2018 “just to try”. After losing 1 house in Florida on XEM in 2018, Sviatoslav finally decided to trade wisely. He is one of the most analytical and data-driven traders in the crypto industry.
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