Liquidity mining is a mechanism or process in which participants supply cryptocurrencies into liquidity pools, and are rewarded with fees and tokens based on their share.
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What Is Liquidity Mining?
A mechanism or process in which participants supply cryptocurrencies into liquidity pools, and are rewarded with fees and tokens based on their share of the total pool liquidity. These pools consist of liquidity in pairs of coins or tokens, accessible via Decentralized Exchanges (DEXs).
In traditional finance (TradFi), brokerage houses and firms serve as market makers, providing purchase and sale solutions for investors. They are compensated for the risk in holding assets to provide liquidity to the market, and also earn a profit through the spread between the asset bid and offer price – or example, when an investor sees that a particular stock has a bid price of $100 and an ask price of $100.20, this indicates the market maker has bought the shares for $100 and is selling them for $100.20, earning a profit of $0.20.
Unlike TradFi exchanges, DEXs are always available for trading via the usage of AMMs and liquidity pools. A basic liquidity pool creates a market for a particular pair of assets on a DEX – i.e. UDSC/RIN. When the pool is created, a liquidity provider sets the initial price and proportion referencing the market to determine an equal supply of both assets. This concept of an equal supply of both assets remains the same for all the other liquidity providers willing to supply liquidity to the pool.
Liquidity providers are incentivized in proportion to the amount of liquidity they supply to the liquidity pool. When the trade is facilitated, the transaction fee is proportionally distributed among all liquidity providers, and smart contracts govern what happens in the liquidity pool, where each asset swap facilitated by the smart contract results in a price adjustment.
Author Bio: Hisham Khan, CEO of Aldrin
Hisham Khan comes from a decade-long background in managing and building robust and innovative financial and enterprise technology. With an extensive career at Bloomberg and based in New York, Hisham has worked as a project manager with some of the world’s top engineers. It was here where he discovered the transformative impact of cryptocurrencies, and has since left Bloomberg to build comprehensive and accessible trading tools through Aldrin. His core mission is to make advanced crypto trading and strategy development available for everyone.