Liquidity mining, along with yield farming, is part of the crypto agricultural phenomenon which gained huge traction in 2020 with the rise of Decentralized Finance (DeFi).
In essence, liquidity mining is a network technique where users supply the capital to a project’s protocol in return for a reward of fees (Eth) and/or the project’s native token.
By adding the appropriate crypto to a designated pool, users increase the liquidity of that token on the market and users get rewards. Supplying liquidity in this manner allows projects to be supported and to distribute their tokens while liquidity providers can earn a substantial percentage in return for increasing the size of a particular token pool.
Being compensated for providing liquidity is not a new concept and has been commonplace within traditional financial and banking sectors for many years.
Liquidity Mining is akin to Automated Market Making (AMM) with traditional market makers being a key part of the trading pits. They have highly capitalized traders with high-capital availability or standards, who profit by providing liquidity to the rest of the market, buying wholesale, and selling for a slight profit. They thus ensured the players in the market could always buy and sell, basically acting as ‘market makers’.
Although the concept today is similar, the function is very different and computer systems run AMM algorithms for computerized traditional trading systems and also more recently in the world of decentralized finance.
DeFi exploded in 2020 as users participated in a protocol by locking in funds and in return, gaining the redistribution of the project’s native token which is seen by many as a fairer way to distribute governance tokens.
Liquidity farming in the cryptocurrency space has exploded in popularity with all the other crypto agricultural innovations such as the more complex Yield Farming which we discuss in the next chapter.
With the rise of DeFi and new ways of earning passive income from your crypto being experimented with, some projects are looking for a more gamified approach.
Aavegotchi is one such example that aims to bring the complexities of Defi and NFT trading into the framework of a user-friendly gaming environment. Playing the game enables participants to utilize NFTs to mine various cryptos with Aave liquidity protocol, a decentralized liquidity provider. These hybrid Defi/NFT innovations using a gamification technique have the potential for enabling people who are less ‘number-focused’ to be able to achieve a similar, if not better, return on investment through gaming than with more traditional methods.
Who knows exactly where these new financial instruments will take us? One thing is certain: the future is beginning to look like something our parents would find hard to believe could be true.
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