Liquidity mining is a method that allows users to earn commission dividends by staking cryptocurrencies in a liquid capital pool through smart contracts. It is a new trend of DeFi, which enables cryptocurrency investors to maximize the use of their crypto assets and obtain higher returns. Indeed, anyone can participate in liquidity mining. Simply put, investors can indirectly become market makers through liquidity mining to get dividend rewards.
Liquidity pool
When it comes to liquidity mining, it’s important to mention liquidity pools. The liquidity pool is the core of many decentralized exchanges. Users can add liquidity by injecting funds into the liquidity pool to obtain transaction fee dividends. Therefore, the funds of liquidity providers will not be used for other people’s capital turnover or project investment, nor will they participate in the shares of a company or fund but will be used for market-making services. The concept is that Automatic Market Maker (AMM) improves the market’s liquidity, attracts transactions, and thus obtains more commission dividends for investors.
Transactions that support AMMs will have a corresponding capital pool for the market, and the capital pool will provide market-making funds for the AMM. When trading, the number of two cryptocurrency assets in the market fund pool will remain the same as the product. Thus, users can become market makers by providing liquidity to the fund pool and earning. Dividends from transaction fees are shared according to the size of the contribution of the funding pool used to automatically make the market.
For liquidity providers, the income they earn comes from the transaction fees generated by the trader during the transaction. For example, the liquidity mining service of the BigONE Exchange will be distributed according to the established fee dividend ratio. The commission dividend is the income obtained by users participating in liquidity mining.
How does liquidity mining work?
The operation of liquidity mining is closely related to liquidity providers and liquidity capital pools. The liquidity provider contributes funds for the liquidity capital pool to obtain commission dividends. The liquidity capital pool offers sufficient liquidity for market transactions, thereby increasing the transaction volume of the market to attract more commissions. A part of the commissions generated in the market is then distributed to the corresponding liquidity providers according to the share of each liquidity provider.
How to choose high-quality liquidity mining projects
Generally speaking, investors use what’s termed “TVL” as a measure of high-quality liquidity projects. TVL is short for Total Value Locked, a figure that represents the spot value (usually in fiat terms i.e., USD) for all the assets that are currently staked in a specific protocol. The overall locked-up value will increase with the value of the cryptocurrency, leading to the occurrence of excessive asset growth in the project. Therefore, when calculating the TVL, the factors affecting the price increase of the cryptocurrency must be excluded.
It is a misunderstanding to use TVL as an indicator to measure high-quality liquidity projects. This is because the purpose of TVL is to measure the amount of funds in the smart contract of the project, like deposits and reserves in traditional finance industries. Therefore, if the number of cryptocurrencies remains the same or even decreases, TVL can still increase due to an increase in the price of cryptocurrencies. This is the fundamental reason why the TVL indicator can mislead users.
Therefore, it is recommended that users instead use “ATVL” as an indicator to measure high-quality liquidity projects. ATVL is the abbreviation of Adjusted Total Value Locked, which means the total value of adjustable locked positions. The ATVL indicator can provide users with the price of the first 30 days or 90 days of the locked-up cryptocurrency price, which can be used to compare with the TVL indicator to see if it is affected by the number of cryptocurrencies or the current price of cryptocurrencies to make more accurate judgment. To pinpoint the reason for the asset growth of the liquidity project, in order to choose the most suitable liquidity mining project.
The risks of liquidity mining
Smart contract: Smart contracts are composed of computer code, so there may be code vulnerabilities or compatibility issues, which may be attacked by hackers and cause loss of user assets.
Arbitrage risk: The arbitrage risk is caused by the insufficient depth of the liquidity fund pool, which means it is easy to be manipulated by the liquidity providers who hold a higher share of the liquidity fund pool for arbitrage.
Risk of impermanence: When the liquidity provider deposits funds in the liquidity pool, the price of the encrypted asset changes, which is what we often call the intra-pool and out-of-pool changes in the liquidity pool. When the price changes more significantly, users suffer losses. The more likely it is, this is called impermanence loss. No matter which direction the price changes, impermanent losses will occur. As long as the relative deposit price changes, impermanence losses exist. This kind of loss usually appears in the initial stage and is a temporary asset loss, which is non-permanent. As the market-making time increases, transaction fees gradually accumulate, prices gradually return, and the loss will be progressively wiped out.
Our upcoming liquidity mining
DeFi products are based on public chains and smart contract mechanisms and are committed to providing open services that cannot be tampered with and do not require permission. Presently, the threshold for participating in liquidity mining through decentralized exchanges is relatively high. In addition, users need to be familiar with the use of digital wallets, understand and be familiar with security-related functions such as private keys and mnemonics.
In contrast BigONE Exchange offers a variety of accessible crypto liquidity mining; to participate, users need simply select projects from the mining options. We recommend that everyone participate in the upcoming liquidity mining because it has the benefit of high profit, low threshold, low risk, and low cost. It should be noted that any investment involves risks. As a result, we would remind all investors that before engaging in liquidity mining, they should thoroughly research and educate themselves about the subject first.
