What is Liquidity Mining?

Liquidity mining or liquidity mining is a characteristic and strategy of some decentralized finance protocols (DeFi) with which they seek to attract users. This focuses on incentivizing the injection of liquidity in the protocol in exchange for distributing among users a series of tokens that give access to the governance of the project and that can also be exchanged for better rewards or for other cryptocurrencies. 

El term of liquidity mining or liquidity mining, is a strategy by which DeFi (Decentralized Finance) protocols, They seek to capture the attention of users so that they can inject funds into said protocols. This with the intention of receiving rewards in the form of Tokens that can be traded on or off the platform, or simply do hodl of them, and receive better earnings with the increase in the value of said tokens received.

Without a doubt, a very interesting way to attract investment and that at the same time, has completely transformed the DeFi world within Ethereum.

Liquidity Mining, an unconventional form of mining

On the other hand, liquidity mining or liquidity mining is closely related to the yield farming. The yield farming is; a strategy that seeks to generate profits by making investments in various platforms taking advantage of different market variables. However, we usually talk about liquidity mining when a DeFi protocol activates a functionality that allows its users to receive rewards for the fact of depositing and blocking capital on their platform. The rewards are generally received in the form of governance tokens.

These tokens may or may not give voting power within the protocol. In addition, they regularly offer access to interest or rewards that are paid regularly to their holders. In this way, the more money they block on the platform, the more tokens they receive and the more rewards they obtain, thereby making higher profits.

The term liquidity mining It comes because it is the injection of liquidity. This injection of liquidity by investors allows them to "mine governance tokens" that are delivered to those who participate in the system. It is, let's say, the mining mechanism of that platform, and it is again very related to the concept of staking.

Liquidity Mining, the start of a fever

The liquidity mining fever is quite recent, in fact, many attribute to Compound this fact. It all started on 15 June of 2020, when Compound, took out its governance token COMP. At the time, the token came out with a market price of about $ 60 USD, and its market capitalization was $ 0 USD.

However, Compound already had a significant user base and as soon as they began to exploit liquidity mining, everything changed. As of June 20, 2020, the COMP token had a value of $ 313 USD and a capitalization exceeding $ 800 million USD. And not only that, the total blocked value (TVL) or cryptocurrency funds blocked in Compound reached over $ 511 million USD, reaching its current highest point, with a TVL that exceeds $ 900 million.

This clearly tells us that liquidity mining is capable of revaluing a platform in ways never seen before, and that caught the attention of many developers and other DeFi platforms. It didn't take long for platforms like Balancer, AAVE, and even the same Uniswap joined the club of platforms with their own tokens and tokenomics focused on liquidity mining.

Objective of liquidity mining

However Why is liquidity mining so important on DeFi platforms? Well, the answer is quite simple: it is a way to encourage investment and injection of liquidity within the platform.

The liquidity providers or LPs, by investing in that will obtain rewards for their participation, and generally that rewards are given by a token from that same platform. These tokens are generated according to the protocol's programming, and are distributed among liquidity providers as part of their rewards. While most of these tokens are useless outside of the DeFi platform that generates them, the truth is that the creation of exchange markets and speculation around these tokens cause their value to skyrocket.

Let's take Andre Cronje as an example. Cronje comments that the YFI token has no real value, since its usefulness is simply that of a "governance token", although the YFI protocol is developed solely and exclusively by him. Basically, it tells us about a token with no real utility.

However, the community does not see it that way and in fact, the YFI token currently (October 2020) is worth $ 13.238 USD, much more than Bitcoin itself. The token even reached over $ 40 USD, thus demonstrating the enormous fever that exists around these tokens and liquidity mining. Of course, these YFI tokens are generated and distributed only to those who participate in the system, and there are two objectives of liquidity mining:

1. Token distribution among your investors, making these better their positions and profits on the platform.
2. Generate an anchor and catch value. Where, taking into account that these tokens have no value, liquidity mining creates an "input-output" relationship associated with an investment given by a liquidity provider. This is what offers a minimum value to the token and the rest is done by speculation in the markets.

Pros and cons of Liquidity Mining

If we examine liquidity mining, we can find the following advantages:

1. In the first place, it is a great incentive and attraction for investors. Offering rewards for participating in the platforms attracts a lot of attention from investors, especially if these rewards can mean big profits. Thus we have that liquidity mining platforms tend to suffer from huge growth explosions in a very short time, driven by the high participation of investors.
2. Additionally, the growth of the platform drives profits. Liquidity mining platforms can, in a very short time, multiply the investments that are made within the platform. If, in addition, said platform allows the realization of loans that can be invested in the same platform or in another (using yield farming), the growth is even more explosive.
3. Most of these protocols are decentralized or have high degrees of decentralization, so anyone can participate in them.

However, not everything is so simple, and in the cons section we can find:

1. They are difficult to use and highly technical platforms. If a person does not have basic knowledge of financial tools, they may well find themselves in a very broad linguistic and technical limbo.
2. Currently most liquidity mining platforms are rooted in the Ethereum blockchain, and its enormous growth (along with the DeFi ecosystem in general) has pushed the network to full capacity. Currently, DeFi trading on Ethereum is not cheap at all.
3. On the other hand, if the user does not consider some aspects related to the activity, such as the expense in commissions, the collaterality indexes, the fluctuations of the cryptocurrencies in the market, he may end up losing his money.
4. Additionally, liquidity mining platforms (such as yield farming) are subject to high volatility. In fact, many specialists consider that such platforms behave as "bubble creators" more typical of a central bank eager for power and money, than of healthy financial spaces.
5. Finally, we are also presented with the serious problem of the security of smart contracts, which we saw in the case of yield farming.

Platforms to take advantage of Liquidity Mining

Among the platforms for excellence to take advantage of liquidity mining we can mention:

1. Compound, where liquidity providers earn COMP tokens for their participation. These tokens can be exchanged internally on the platform or exchanges (centralized or decentralized) in order to obtain profits in other different tokens.
2. AAVE, is another project where we can put liquidity mining into practice, something that is possible due to a recent update of the protocol. In fact, with the migration of its old ETHLend token to the new AAVE token, this practice could bring better returns to its holders.
3. Balancer, is a project that recently decided to update its protocol to launch the BAL token, a governance token that enables liquidity mining on its platform.
4. Corners, bases all its operations and profits within its platform on liquidity mining together with a decentralized yield farming system applied in the creation of liquidity pools for other protocols (such as Compound or Uniswap). The intention with this strategy is to maximize profits, considering that Curve only works with stablecoins.
5. Uniswap, is the DEX par excellence in the DeFi world. However, recently its development team introduced the UNI token. This is a liquidity mining token that has led to an explosion of use of this protocol. In fact, Uniswap currently ranks first with a locked value (TVL) of about $ 2,1 billion.
6. yearn. finance, Andre Cronje's well-known project brings together the best of yield farming and liquidity mining in one place. In fact, it is the maximum exponent of liquidity mining given the surprising value of its token