Introduction

Earning passive income is one of the best ways to invest in cryptocurrencies, and there are several ways to do that, including staking your assets, lending them, and yield farming in DeFi (decentralized finance) platforms.

Decentralized finance is a new fintech application that seeks to disrupt traditional financial markets using decentralized networks such as blockchains. DeFi platforms work by eliminating centralized financial intermediaries allowing market participants to interact in a peer-to-peer (P2P) manner.

Yield farming is a broad categorization for all methods used by investors to earn passive income for lending out their cryptocurrencies. They can receive interest, a portion of fees accrued on the platform they are lending their tokens or new tokens issued by these platforms.

Liquidity mining is one of the more common ways of yield farming where investors can earn a steady stream of passive income. In this guide, we will discuss what it is, including the risks and benefits to investors engaging in the practice. Not only that, but we also highlight some of the best liquidity mining platforms for anyone looking to make use of their packed crypto.

Further reading on DeFi:whats the difference between crypto com and defi wallet

What is Liquidity Mining?

Liquidity mining is a process in which crypto holders lend assets to a decentralized exchange in return for rewards. These rewards commonly stem from trading fees that are accrued from traders swapping tokens. Fees average at 0.3% per swap and the total reward differs based on one’s proportional share in a liquidity pool.

In the case of Uniswap, and all DEXs who use the same AMM model, crypto holders must provide equal portions of tokens (in terms of value). If we have 4 ETH tokens (where each is priced $2,500) we have a total of $10,000. Therefore, lending 4 ETH means that we also have to provide 10,000 USDT (valued at $1 per token).

Again, the liquidity provided to Uniswap will be granted to clients who trade assets from the ETH/USDT (or any other) liquidity pool. These fees are then collected and distributed to liquidity providers (LPs).

The end result is a symbiotic relationship where each party receives something in return. Exchanges receive liquidity, LPs fees, and end-users have the ability to trade in a decentralized fashion.

Conclusion

Liquidity mining is simply a passive income method that helps crypto holders profit by utilizing their existing assets, rather than leaving them inactive in cold storage. Assets are lent to a decentralized exchange and in return, the platform distributes fees earned from trading to each liquidity provider proportionally.

Liquidity mining is the first yield use case in DeFi. It existed during the very beginning of DeFi’s rise. However, as the market gradually evolved the market shifted to a different yet similar passive investment method: yield farming.

Although yield farming is based on liquidity mining, we will use the next lesson to figure out the differences between them and discover which method is more profitable.

Key Terms and Concepts (Explained)

To effectively participate in a DeFi protocol as a liquidity provider, there are terms and concepts with contextual meaning that you will need to be aware of and understand. Some of these include:

  • DEX – this is a short form for decentralized exchange, which is a platform that runs autonomously without direct intervention from a centralized party such as a company. Dexes are trading platforms to which liquidity providers contribute their digital assets.
  • Yield – this is the reward offered to liquidity providers in the form of trading fees or LP tokens. In other DeFi platforms, yield is the interest rate accrued to participants for providing liquidity or holding stakes in these projects.
  • CeFi – stands for centralized finance, and it refers to the institutions within the cryptocurrency market that offer financial services. It is the opposite of DeFi.
  • TradFi – in full, this term stands for traditional finance, and it refers to the conventional financial institutions such as banks, stocks exchanges and hedge funds.TradFi is different from CeFi even though both terms refer to centralized financial structures, the contexts vary because CeFi is used in reference to blockchain and TradFi is used in reference to conventional financial markets.
  • AMM (Automated market maker) – AMMs are smart contracts designed to hold the liquidity reserves within a pool. It is the AMMs to which the LPs deposit their assets and traders interact to exchange their crypto.

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