What is Liquidity Mining?
Liquidity is the ability of a financial instrument to be converted back and forth to fiat currency or other investment assets. Cryptocurrency trading platforms take various measures to ensure liquidity for the investors on the platform.
However, DeFi markets have limitations when it comes to accessing trading liquidity for them. Liquidity mining is a way for DeFi to address the issue of liquidity constraints on the platform. It is a community-based and data-driven network that generates more liquidity.
Miners are incentivized with rewards by contributing to the liquidity. The process requires miners to deposit or lend virtual currency funds. This creates a mining network that offers greater liquidity on the investment pool.
At the same time, the contributors are also able to earn interest income generated based on their participation. Another feature of the platform is that investors are able to operate a market-making trading bot. The bot manages order book on the trading platforms.
Liquidity Mining Vs Proof-of Work Mechanism
Liquidity mining shares many similarities with Proof-of-Work (PoW) consensus model. One of the common features is that miners use open-sourced software to access scarce resources such as cryptocurrency inventory.
However, unlike a PoW blockchain, investors on the platform are able to use other features in comparison to computational power such as token inventory. In this manner, the trading governance remains democratic.
At the same time, liquidity miners do not need to use expensive mining tools. On the other hand, the rewards issued to the miners are in the form of their native tokens.
What are Governance Rights?
Liquidity miners have governance rights that are granted using token rewards. LMs or Liquidity Miners are able to use various cross-chain capabilities. Some of these networks do not require the investors to trade directly on the blockchain before utilizing it.
There are some features such as atomic swaps allow investors to access LMs without direct investment positions. On the other hand, the tokens allow the investors to gain voting rights.
However, different LMs have different minimum token contribution requirements to unlock the rights. The contributors should go through the terms of services in order to measure three important criteria to gain their rewards, mentioned below:
Order Amount
The order amount is the first feature. Depending on the size of the order in question the reward ratio for the investors is determined. The main goal of the investors is to retain a high level of participation from the investors.
The Spread
Spread is the difference from mean price of the order.
The Timeframe of Order Book
The duration of the order opening allows the LM contributors to earn more rewards. However, governance tokens are also speculative in nature. Most LMs offer contribute in LMs using governance coins that incentivize investors to purchase the DeFi coins to resale them for a higher price point.
However, the cryptocurrencies with the greatest amount of transparency tends to go the farthest.
Liquidity Mining Utility
Liquidity miners are able to address some issues associated with DeFi sector. LMs open funding channels for a given cryptocurrency project.
DeFi projects are able to set up self-created capital pools in the form of LMs that allow new projects on the platform to access stabilized liquidity options. The other alternative for companies is to pay hedge funds millions of dollars to offer liquidity injection for the sector.
Another important feature of LMs is that investors are able to earn interest income from the LMs. At the same time, the size of the LM increases in direct proportion to the generation of more interest revenue.
In this manner, the LM contributors are able to yield farm with the added advantage of creating incentives in the form of interest rates. It means that more lending lead to greater interest rewards.
Conclusion
LMs offer many advantages for LMs such as earning passive income in the form of interest. At the same time, they are able to provide frictionless on-boarding for DeFi investors like LPs. But they also carry investment risks such as security threats such as viruses or technical bugs etc.
