Liquidity mining quickly emerged as the new DeFi killer app superpower. It enables users to receive tempting rewards by supplying liquidity to decentralized exchanges (DEXs). In AMMs, liquidity providers add to a liquidity pool by depositing two tokens with equal value. In exchange, they receive a portion of the trading fees that occur in that pool. Uniswap, PancakeSwap, and Curve are certainly at the forefront of the liquidity mining craze. They lure in consumers with irresistible offers of high annual percentage rates (APRs) that often exceed those available from banks and credit unions. To join liquidity mining, users must have a non-custodial crypto wallet that can connect to decentralized applications (dApps). This is particularly important because the participating projects are required to do thorough homework. We recommend spreading your capital across multiple liquidity pools and exchanges to mitigate risk. Code audits by established third-parties are key as much for the platforms used in liquidity mining as those being used in liquidity mining. Liquidity mining provides a unique opportunity to earn passive income. It has its dangers, such as impermanent loss, where fluctuations in token prices decrease the value of your deposited tokens.
Understanding Liquidity Mining
In liquidity mining, liquidity providers deposit two tokens of equal value into a liquidity pool. This process advances good trading while fostering market stability, which benefits everyone. This contribution helps improve DEXs by allowing for easier trading on decentralized exchanges (DEXs). A smart contract manages the liquidity pool. It safely stores two tokens, such as ETH and USDC, automatically enabling traders to seamlessly swap between the two.
Each time a trader makes a swap, a small percentage is collected as a fee. Liquidity providers earn a share of the trading fees generated within the pool every time a trader makes a swap. This incentivizes them to provide liquidity. The fees are allocated back to the providers proportionally to each provider’s total share of the pool.
Liquidity providers are usually given LP (liquidity provider) tokens that represent their share of the pool. These LP tokens can be staked into an entirely separate contract—which is usually called a master contract. When providers stake their LP tokens, they’re generating additional rewards. These rewards usually take the form of the DEX’s native token or other crypto assets, creating new incentives to participate.
Platforms and Rewards
Uniswap, PancakeSwap, and Curve are well-known platforms that allow you to mine liquidity. Each platform has its own assorted pools and reward structure. Uniswap is known for its simplicity and wide range of tokens, PancakeSwap offers yield farming opportunities on the Binance Smart Chain, and Curve specializes in stablecoin swaps with lower slippage.
Liquidity mining sometimes presents the opportunity for triple-digit annual percentage rates (APRs), frequently exceeding rates found in traditional finance. Additionally, the APRs can be shockingly attractive, sometimes landing in double or even triple-digit percentages. This unique aspect of the network makes it a perfect option for those looking to generate passive income through their crypto holdings. These seemingly astronomical high returns are typically driven by a platform’s need to incentivize liquidity and bootstrap its ecosystem.
Liquidity mining is a great source of passive income to liquidity providers. Through depositing their tokens into liquidity pools, users are able to earn rewards without the need for trading or continuously managing their assets. This new income stream presents a big opportunity. It’s ideal for crypto investors wanting to realize returns on their crypto assets while avoiding the risks of active trading.
Getting Started and Mitigating Risks
Once liquidity mining has begun, you need a non-custodial crypto wallet that’s able to connect to decentralized applications (dApps). Popular wallets are MetaMask, Trust Wallet, as well as hardware wallets such as Ledger. These wallets will enable users to use DEXs and buy, store, spend and manage their crypto assets securely and privately.
Liquidity mining takes a lot of project-specific research. Just as importantly, it’s prudent not to stake all your crypto assets in one liquidity pool or decentralized exchange. Conducting extensive due diligence on the project’s fundamentals, team and tokenomics is crucial before engaging in liquidity mining. Having your investments spread across different pools and AMMs is a good practice. This approach reduces the risk of losing all the money if one project loses its funds or has a security breach.
Comprehensive code audits by reputable third parties are absolutely necessary for the platforms where liquidity mining occurs. This is to both check for any potential vulnerabilities and to ensure the smart contracts are secure. Platforms that are regularly audited for security are usually safer than other platforms, as they have proven their commitment to the highest level of security and transparency.
Impermanent loss is a risk in liquidity mining, where a change in token values leads to a withdrawal of less than what was originally supplied. This happens whenever the price ratio between the two tokens in the pool fluctuates wildly. If one asset increases in value and the other decreases, the liquidity provider is left with fewer tokens of the asset they’re holding onto. In the meantime, they find themselves with fewer tokens of the depreciating asset, resulting in a worse loss than simply holding their tokens.
Strategically pairing stablecoins is one strategy for minimizing risk in liquidity mining. Stablecoins, like USDT and USDC, are a type of digital currency explicitly meant to hold a single value over time, usually pegged to the US dollar. Supplying liquidity for stablecoin pairs will greatly reduce the risk of impermanent loss. That’s because the price difference between the two tokens is generally just a few cents.
Liquidity mining rewards come in two stages. The first tier is simply generating a small percent of the trading fees that the pool creates. The second stage is to stake the LP tokens in order to earn extra rewards, including the DEX’s own native token. This two-stage reward system incentivizes long-term participation as well as helps bootstrap the DEX’s ecosystem.
To start liquidity mining on Uniswap, you’ll need a pair of two distinct tokens that have the same dollar value. These tokens will exclusively be added to the liquidity pool. For example, if a user wanted to provide liquidity to the ETH/USDC pool, they would need to deposit equal values of ETH and USDC. This keeps the pool useful and usable for all. This keeps the pool in equilibrium with the desired ratio of the two tokens.
Liquidity mining is simple, it just requires linking a wallet—I use MetaMask—to a DEX like Uniswap. Whenever the wallet is successfully connected to the platform, users can easily choose the preferred liquidity pool and provide the necessary tokens. Now the DEX will give you LP tokens which are a representation of your ownership in the pool. You can stake these tokens to earn even more rewards on top of them!
