Liquid mining or yield farming are not terms you might have heard if you’re new to the crypto world, but it’s something that has gained ground.
Some people look at liquid mining and think of it as a get-rich-quick scheme or a not sustainable way to grow cryptocurrencies. That’s probably why some people are skeptical about Yield farming. But that’s not true.
Yield farming is a legit way to increase your coins, and in this article, I will provide a breakdown of what yield farming is, how to get into it, and answer all your questions.
What is Yield Farming or Liquid Mining?
Liquidity mining, known as yield farming, is a strategy used by decentralized finance investors to earn impressive yields on their capital.
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 AMMs
AMM’s are smart contracts that offer both the buy-side and sell-side of a pair of assets. AMM’s such as Uniswap allow anyone to contribute capital to a trading pair (for example, ETH <-> USDC).
How Do Yield Farmers Make Money?
By providing liquidity to the pair, usually at 50% / 50%, yield farmers can earn the trading fees that accrue when buyers or sellers convert from one of the two 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, crypto networks will provide bonus incentives to provide liquidity for their token. For example, by providing liquidity to the ETH <-> USDC pair on Sushiswap, one is able to 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.
Are Liquidity Mining and Yield Farming Different?
Both terms are used interchangeably, and those that do liquidity mining are also called yield farmers, but there’s a slight difference.
Yield farming is 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, 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 Become A Yield Farmer?
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 automated market maker pair buys or sells one of the two assets in response to market price shifts. If one asset significantly changes 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 Platforms/Liquidity Pools For Liquidity Mining
Yield farming is the fuel of DeFi, and these are some of the top platforms to do yield farming or liquidity mining:
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 at 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 token. I gave an example of how yield farmers make their money on Uniswap above.
SushiSwap became popular first due to rewarding liquidity providers on Uniswap for staking their Uniswap LP tokens on the SushiSwap protocol with a lot of SUSHI tokens.
Then, Chief 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 though the damage had already been done.
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 because it can mitigate some impermanent loss as 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 to 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 platforms – we have reviewed some in this article.
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 Platform Are You Going To Provide Liquidity?
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 through your cryptocurrencies.