Liquidity mining

Liquidity mining means providing crypto to a DeFi protocol in exchange for rewards. This helps other users swap tokens or borrow crypto.

What is liquidity mining?

DeFi stands for financial services that use crypto without a central intermediary. With liquidity mining, you deposit tokens into a liquidity pool: a shared supply of crypto that a protocol uses for transactions or loans.

Your crypto is temporarily locked in a smart contract. This is a program that automatically carries out the terms of an agreement. As a reward, you may receive a share of the transaction fees and sometimes extra tokens. These returns aren’t guaranteed.

An example of liquidity mining

Suppose you deposit ETH and USDC, two types of tokens, into a pool in equal amounts by value. Traders can use this pool to swap ETH and USDC.

You receive proof of your share of the pool. As long as your tokens remain there, you may earn a share of the transaction fees paid. The protocol may also distribute extra tokens as a reward.

Why is liquidity mining important in crypto?

Liquidity mining helps DEXs, or decentralized crypto exchanges, make swaps possible. Without enough crypto in their pools, transactions may cost more and be less efficient.

Crypto news may report that a protocol is offering new rewards or higher returns to attract more liquidity. That doesn’t automatically mean participating is safe or profitable. The value of reward tokens may fall, and costs such as gas fees can reduce your returns.

There are also risks. With impermanent loss, your position may lose value because the price ratio between the tokens in the pool changes. Programming errors or security vulnerabilities in smart contracts can also cause problems.