How Does Liquidity Mining Work
Participating in these liquidity pools is very simple as it involves depositing your assets into a common pool called a liquidity pool. The process is similar to sending cryptocurrency from one wallet to another. A pool typically consists of a trading pair such as ETH/USDT. As a liquidity miner (or provider), an investor could opt to deposit either asset into the pool.
By depositing their assets into the Defi platforms, the (LPs) make it easier for traders to get into and out of positions with the trading fees partly used to reward them.
The more an LP contributes towards a liquidity pool, the larger the share of the rewards they will receive. Different platforms have varying implementations, but this is the basic idea behind liquidity mining.
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.