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 closely 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:
- Token distribution among your investors, making these better their positions and profits on the platform.
- Generate an anchor and catch value. Where, taking into account that these tokens have no value, liquidity mining creates an “entry-exit” 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.