LIQUIDITY MINING:
WHAT IS IT, HOW DOES IT WORK AND HOW HAS IT SHAPED DEFI
INTRODUCTION
According to Coinmarketcap, liquidity mining is “A mechanism or process in which participants supply cryptocurrencies into liquidity pools, and are rewarded with fees and tokens based on their share of the total pool liquidity. These pools consist of liquidity in pairs of coins or tokens, accessible via Decentralized Exchanges (DEXs).”
How it works.
Liquidity mining, also called yield farming, is an investment vehicle that requires investors to provide liquidity (capital) to a liquidity pool on a Decentralized Exchange (DEX) through a smart contract.
Liquidity mining is crucial to DEXs because they need the liquidity to enable the trades between different token pairs. Each liquidity pool consists of two tokens, which represent a single trading pair. DEXs tend to require a 1:1 liquidity pool ratio, which means that the liquidity pool must consist of an equal amount of both tokens, which are usually contributed by investors.
Liquidity mining is not a new concept, it was first introduced by IDEX in 2017, further advancements were made by Chainlink in 2019, and it reached a new height in popularity after Compound and Uniswap popularized it in June 2020. Liquidity Mining, though relatively new, is largely responsible for the DeFi ecosystem’s 10x growth in size in 2020.
Liquidity Mining contributed to the monthly volume growth of DEXs from a January 2019 value of $39.5 million to $45.2 billion in January 2021. As of November 2021, the total value of DEXs is estimated at $112.08 billion. Analysts predict that the growth will continue into the future.
BENEFITS TO INVESTORS
Transaction Fees: A majority of DEXs operate using Automated Market Makers, also called AMMs. AMMs are smart contracts that offer more efficient regulation of all trading procedures than order books that were previously in use. On platforms that use AMMs, traders trade directly with other traders. AMMs facilitate token swapping, which is the exchange of one token for another within the same liquidity pool. Each trade requires the payment of a fee, which the AMM collects and distributes among the platform’s investors as a reward for providing the liquidity the traders need.
More risk — higher rewards
Token Value Growth: Native tokens continue to rise in value as the platform becomes more popular and demand for the token rises. Profits from liquidity mining could reach up to 100% a year, and up to 10,000% a year for more risky projects.
Governance: Some liquidity mining platforms distribute governance tokens, which give investors the ability to vote, contribute to how the protocol works, and shape its future.
TYPES OF LIQUIDITY MINING PROTOCOLS
Fair Decentralization Protocol: Platforms that fall under this category seek to ensure equitable rewards and contribution to governance for all community members. This protocol equitably distributes native tokens to all community members and uses an agreed upon criteria to execute equal distribution of governance tokens, which guarantees proper decentralization. When the platform is ready for launch, control transitions to the community.
Progressive Decentralization Protocol: Platforms that use this protocol prefer a slower transition of control to the community. Developers gradually distribute governance tokens over a period of time, the aim of which is to ensure whales or institution traders do not accumulate a significant proportion of the governance tokens.
Marketing-Oriented Protocol: Platforms that use this protocol operate differently from the others. These are platforms whose developers are desirous of building a lot of publicity prior to launch, so they incentivize investors to market the platform extensively in order to build a large userbase and equally large liquidity pool. Investors’ qualification for ownership of governance tokens is usually contingent on advertising the platform.
RISKS OF LIQUIDITY MINING
While liquidity mining offers the prospects of rapid wealth creation, it also has risks which investors should consider. Below are some of the risks:
Technical Risks: Advanced protocols are usually built on a very complicated source code which could lead to developers overlooking loopholes which can easily be exploited by hackers. Investors should ensure that they carry out thorough analysis to ensure the safety of their platform of choice before making an investment. It is also advised that investors ensure platforms are carrying out careful code audits.
Exorbitant Transaction Fees: Most smart contracts are currently supported by the Ethereum blockchain network, which has a reputation for having very high transaction fees. High transaction fees could discourage small investors from contributing to liquidity mining pools in favor of whales and institutional investors who are capable of absorbing the high fees. However, as Ethereum transitions to the proof-of-stake (POS) consensus, the playing field will be levelled, opening up the rewards of liquidity mining to a broader audience.
Cache DEFI Project
Cache DEFI Project will be launching the CACH Token on Jan 15, 2022.
Cache DEFI Project will create an environment to decentralize crowdfunding and venture capital. Cache Tokens (CACH) to be used in transactions, transparent reserve fund & provide liquidity mining options. Create stock bearing tokens for companies to enable them to raise funds privately, crowd fund or IPO’s. Tokens will be distributed over 81 years to provide stability and future earning potentials.
