If you’re new to the crypto world, you might not have heard of liquid mining or yield farming. Nevertheless, you will learn about them and how to increase your passive income by mining liquidity today.
Liquidity mining is sustainable because the crypto market will always need liquidity. However, some view it as an unsustainable way to grow your income. Sure with the crypto market in general, there’s no stability – unless you’re dealing with stable coins – but as with every other investment, you monitor the market and change strategies when you need to.
Yield farming is a legit way to increase your coins. This article is a yield farming guide. I will break down what yield farming is, how to get into it, yield farming tips, and answer all questions about getting yield farming returns.
What is Yield Farming or Liquid Mining?
Liquidity mining, also known as yield farming, is a strategy used by decentralized finance investors to earn impressive yields on their capital. It is providing liquidity to trading pairs to earn from trading fees and governance tokens.
Trading pairs can be any two coins, or for some yield farming platforms, more than two. Such coins can be stable coins, unstable coins, or stable and unstable coins, depending on the platform.
Liquidity mining incentives increase existing fees earned by providing liquidity to trading pairs on decentralized exchanges known as “automated market makers” or AMM’s.
What are Aautomated Market Makers
AMM’s are smart contracts that offer both the buy-side and sell-side of a pair of digital assets. AMM’s such as Uniswap allow anyone to contribute capital to a trading pair (for example, ETH <-> USDC).
How Yield Farming Works
By providing liquidity to the pair at 50% / 50%, yield farmers can earn trading fees that accrue when buyers or sellers convert from one of the assets to the other. On Uniswap, trading fees are 0.3%, and you earn a fraction of this equivalent to your share of the liquidity pool or the total amount of capital in that pool.
For example, we provide $500 USDC and $500 of ETH to a Uniswap liquidity pool, totaling $1,000. Let’s hypothetically say the total size of the ETH <-> USDC pool is $100,000, so we own 1% of the total pool.
If trades total $50,000 today between the two assets, there are $150 of trading fees ($50,000 * 0.003). Our daily earnings are 1% of $150, or $1.50. This is added to our current share, with 50% in ETH and 50% in USDC, always maintaining equilibrium.
On top of this, you will earn rewards or bonus incentives from crypto networks to provide liquidity for their token. For example, by providing liquidity to the ETH <-> USDC pair on Sushiswap, one can earn distributions of the SUSHI token in addition to the ETH <-> USDC trading fees. When added up, these two “yields” can often result in 40%+ APR earnings on the principal. Now, this is liquidity mining.
What is the Purpose of Farming Yield?
For you as an investor, it is making extra income. For the DeFi platform that powers your yield farming, it is getting liquidity for transactions. So, by providing your pairs, you provide liquidity for transactions that concern those coins on the platform.
Unlike centralized exchanges, decentralized exchanges do not have money stored somewhere to power transactions so they rely on third parties like the yield farmers to provide liquidity through liquidity pools.
Are Liquidity Mining and Yield Farming Different?
Both terms are used interchangeably. Those that do liquidity mining are also called yield farmers, but there’s a slight difference.
Yield farming involves simply moving crypto assets around to whichever pool offers the best APR at that time. Yield farming is called liquidity mining when a yield farmer gets a new token along with the usual return from mining in exchange for their liquidity.
What is a Token?
A token is a type of cryptocurrency representing a specific use, like ownership in something (a piece of a liquidity pool or yield farm, for example) or access to a service (access to ads in Brave Browser through BAT, for example).
Tokens are significant for Ethereum, hence ERC-20 tokens.
There are tokens, and there are governance tokens. Governance tokens give holders the right to vote on changes to a protocol, such as how much it costs to borrow, how much savers earn, and other changes to parameters that govern such issues.
How Do I Do Yield Farming Work?
To earn these “liquidity mining” bonus incentives, you must stake the “LP” token, which is a new token that is generated when placing the two assets (Ethereum and USDC in the above example) into the liquidity pool.
The LP token is programmed to automatically rebalance the proportion of the two assets in response to market price changes of either asset, always maintaining the original proportion (generally 50/50).
When providing liquidity to a pair, you must be aware of the risk of “impermanent loss”.
What is Impermanent Loss?
Impermanent loss occurs when the AMM pair buys or sells one of the two assets in response to market price shifts. If one asset significantly changes the value in relation to the other asset, then impermanent loss becomes a factor. You can use this impermanent loss calculator.
When a new token or network launches, they will often provide liquidity mining incentives during the first few weeks after launch.
You can think of liquidity mining as a form of supporting early-stage startups by providing capital and earning shares of those startups as a thank you.
In the place of conventional “startups”, we have decentralized networks generally governed by Decentralized Autonomous Organizations or “DAO’s”. In many cases, the token itself allows its holder to participate in a programmatic voting system that governs the direction of the protocol.
Top DeFi Yield Farming Platforms / Liquidity Pools For Liquidity Mining
Yield farming is the fuel of the DeFi markets, and these are some of the top platforms to do yield farming or liquidity mining:
Ubeswap is a fork of Uniswap that runs on the Celo blockchain. Ubeswap is a fast upcoming DeFi platform for yield farming. On Ubeswap, you get 3% of the trading fees along with as many UBE as the APR of the pool you join. We have created a step-by-step tutorial to show you how to do liquidity mining on Ubeswap. Read that to start yield farming.
Uniswap is a popular decentralized exchange and automated liquidity protocol. You can become a liquidity provider in a liquidity pool on Uniswap by depositing an equivalent value to both sides, that is, a 50% – 50% ratio for each underlying token in return for other tokens in the pool.
In return, you will earn a proportion of the transaction fees and the UNI DeFi token. I gave an example of how yield farmers make their money on Uniswap above.
SushiSwap became popular first due to providing reward tokens to liquidity providers on Uniswap for staking their Uniswap LP tokens on the SushiSwap protocol with a lot of reward tokens.
Then, Chef Nomi (the founder) suddenly liquidated over 14 million USD of SUSHI tokens in the development funds. A series of Tweets revealed that he felt entitled to the funds, which drew immense outrage from the crypto community. A few days later, Uniswap was drained of 1.14 billion of its 1.9 billion because of a Liquidity Migration ™ to SushiSwap. Later on, Chief Nomi stepped down.
SushiSwap has bounced back from that and is now famous for its great yield farming opportunities.
The trading fees on the SushiSwap exchange are 0.3%. 0.25% go to those that are providing liquidity in the SushiSwap liquidity pools, while the remaining 0.05% go to the Sushi Bar Pool, which is its staking pool.
You will need to deposit equal amounts of two cryptocurrencies into an existing pool or create your own pool to be a liquidity provider.
Balancer is unique. It can mitigate some impermanent loss because it doesn’t require liquidity providers to add liquidity equally to both sides. Instead, LPs can create customized pools with varying token rations and adjust allocations to fit their needs, which means you can set up a pool in an 80:20 or 90:10 ratio.
You will earn interest off the fees generated on the Balancer Exchange, and you can earn Balancer’s governance token, BAL, by providing liquidity to a pool.
1inch, like the others, is a decentralized exchange or DEX. What sets 1inch apart is that it splits orders between many DEXs and private liquidity providers to provide the best exchange rates.
1inch initially offered a liquidity protocol called Mooniswap that introduced virtual balances to bring more profit to LP. However, it deprecated that and rebranded it to 1inch Liquidity Protocol.
The 1inch Liquidity Protocol has various pools that you can add liquidity and earn fees. To do liquidity mining on 1inch, you need to deposit an equal value of each token into the liquidity pools.
Is Yield Farming Sustainable?
It depends. DeFi yield farming or liquidity mining platforms like those reviewed above have been around for a while and look sustainable. There’s no craze to make a lot of money in a short time.
However, like everything money-making and investments, there are considerable risks, and there are projects that give a bad name to yield farming.
Some yield farming or liquidity mining projects aren’t sustainable and won’t last long because they often raise huge amounts of money in a short time and are abandoned just after that. Some see those types of projects as scams and are beginning to avoid them even more.
Also, some liquidity mining experiments have used experimental and unaudited code, which can lead – and has led – to unintended consequences.
If you want to go into yield farming or liquidity mining, bear in mind that you are investing at your own risk. There is liquidity risk and smart contract risk, but we don’t think it’s going anywhere.
To mitigate risks, go with one of the DeFi protocols – we have reviewed some in this article. Also, read this article on yield farming risks and how to mitigate them to obtain yields in yield farming platforms.
Can I Go Into Liquid Mining Without Crypto Experience & Capital?
Getting involved with liquidity mining can be tricky if you have no previous crypto experience. Some projects like Compound make it easier for beginners, but in general, liquidity mining needs some crypto knowledge and a lot of capital.
Yield farmers usually need to have a lot of cryptocurrency capital because liquid mining has driven high gas fees on the Ethereum network. Nevertheless, there are many rewards, and some top yield farmers have earned as much as 100% APR.
On What DeFi Yield Farming Platform Are You Going To Provide Liquidity to Earn Yields?
We have looked at yield farming in this article. Like some of the money-making or crypto investment opportunities, this one shows a lot of promise. You could make a loss, but you could also make a lot of money in the money markets through your cryptocurrencies.