What are the risks of liquidity mining (Is liquidity mining profitable)?

What are the risks of liquidity mining? What is liquidity mining?

In simple terms, liquidity mining refers to staking or delegating a certain currency to earn its value. When users transfer assets to the platform’s liquidity address (such as ETH-USDT) after participating in the project, a portion of these assets will be placed in a pool, and these funds will be exchanged 1:1 for another currency. This portion of assets will be locked for a period of time based on user authorization and protocol conditions.

Since liquidity mining is an innovative activity, many investors classify it as an investment behavior because it is a new way of investing in digital currencies and a high-potential investment opportunity. So what are the risks of liquidity mining?

1. Inherent risks: DeFi protocols often have some high-risk situations in their lending products; 2. Liquidity mining does not generate revenue using collateral; 3. Due to the lack of support for smart contracts in DeFi protocols, liquidity pool liquidation risk is high. (Note from BlockBeats: If users want to bear any potential risks, please minimize the risks themselves to avoid losses), as shown below:

1) Risks generated by liquidity mining

2. The emergence of liquidity mining allows users to borrow tokens directly from the platform and earn rewards, but they cannot withdraw their own tokens at the same time. This is unsatisfactory for those who have invested millions or even tens of millions of dollars to buy tokens, which puts greater pressure on users. For example, in DeFi protocols, users need to deposit $1 million to $3 million to obtain governance tokens. Therefore, the risks generated by liquidity mining are mainly affected by the following three points: 1. The project party may control a large amount of funds; 2. The token price of a project is detached from the market price, causing the token price to rise; 3. The project party is also easy to manipulate its own token price; 4. In the case of three projects with a small issuance volume and relatively decentralized token distribution, once the assets in the liquidity pool reach a certain quantity, it will cause a token sell-off wave. DeBank is currently one of the hottest products in the DeFi field. It is a DeFi ecosystem built on the BSC blockchain, mainly including the decentralized exchange Uniswap and the synthetic stablecoin protocol Aave.

DeBank’s liquidity mining project is implemented by programming the Ethereum smart contract code and developed by the Ethereum development team. DeBank was officially launched on the mainnet on September 16, 2021.

Is liquidity mining profitable?

Editor’s note: This article is from Xiaonazha Talks (ID: xiaonazha88) and has been authorized for reprint by Odaily Star Planet Daily.

DeFi mining is one of the decentralized financial derivative applications. It allows users to earn returns by mining cryptocurrency liquidity on a platform based on the Ethereum blockchain without the need for intermediaries. In traditional finance, trading parties can directly transfer funds between other exchanges or wallets. The acquisition of liquidity mainly serves two purposes: to place assets in the protocol and to execute specific operations using smart contracts. This enables people to have a clearer understanding of their investment portfolios.

For those who are not familiar with DeFi, liquidity mining may be a good choice. However, in most cases, if investors want to participate in liquidity and the DeFi ecosystem, they need to first store and lock their tokens. In reality, when you want to participate in liquidity mining, you must first purchase tokens and exchange them on the exchange. Currently, the most popular protocols in the market are Uniswap, Aave, and others, whose total market value has already exceeded $1 billion.

According to data from CoinMarketCap, in the past month, the total trading volume of UniSwap and Aave was $444 million, $368 million, and $1.16 billion, respectively. The protocol with the highest trading volume is Balancer, with a transaction volume of $277 million. Balancer currently has more than 100 DEX.

In addition to AMM, Balancer also supports various algorithmic stablecoins (such as USDC, DAI) and some other tokens (such as YFI), which are called “synthetic dollars.” For example, USDT, BTC, ETH, BNB, and LINK. These tokens are pegged 1:1 to Bitcoin. These numbers indicate that cooperation between these protocols may be borderless and they have no actual value support. Therefore, the best way for liquidity mining is to sell tokens to the market and sell them in the secondary market. This practice is also conducive to attracting new customers and improving overall returns.

In the field of DeFi, different factors can affect the liquidity pool due to the different incentive mechanisms of the pools, such as transaction costs, liquidity depth/fees, etc. Generally speaking, the higher the rewards of the liquidity pool, the higher the return, because the project will have more income. In addition, the benefits of liquidity mining are that as long as you hold tokens and are willing to take risks, you can get corresponding token incentives.

For example, if a project promises to airdrop 5 million YAM tokens to all participants, then the price of this token will be very low. That is to say, if the project wants to earn an annualized profit of $10 million, they can only use the token as a reward.