In recent years, various blockchain applications have emerged in an endless stream. The emergence of innovative financial products such as permissionless DeFi modules, Chainlink decentralized oracles, and liquid mining has allowed smart contract developers around the world to rapidly develop, iterate and deploy new Of decentralized applications. So far, the DeFi lock-up volume has doubled tenfold, from less than 700 million U.S. dollars to more than 8 billion U.S. dollars, of which Chainlink’s price-feeding lock-up volume accounts for more than 3 billion U.S. dollars.
The rapid growth of the DeFi industry has benefited from the rapid development and innovation of DeFi technology, which also gave birth to unprecedented financial products and eliminated the inefficiency and counterparty risks in the traditional financial system. The hottest application in the DeFi field recently is liquid mining.
The liquidity mining mechanism encourages users to inject funds or provide other value-added services in the decentralized ecosystem. In return, the platform will issue rewards to them. The miners of liquid mining will obtain the platform’s native governance certificates in proportion to increase their annualized investment yield. Liquidity mining rewards are not included in the income of the platform itself (such as transaction fees generated by decentralized exchanges or loan interest in the currency market), but an additional income. Some projects will also issue liquid mining rewards for other behaviors, such as users participating in platform transactions or supporting communities, marketing, and developer plans.
Liquid mining usually has two main purposes:
- The first is to encourage users to inject liquidity into DeFi applications to increase the total lock-up volume (TVL) and capital supply of the application. Increased liquidity can effectively reduce transaction slippage and enhance the competitiveness of applications, thereby attracting more users to join.
- The second is to fairly distribute the governance tokens of DeFi applications to users. These users deposit funds on the platform and bear the corresponding opportunity costs (such as impermanent losses). Since the tokens are distributed fairly, neither party will be favored, so that a decentralized governance model can be truly realized.
The liquidity mining mechanism used by different DeFi agreements is also different, mainly depending on what they hope to achieve. Some agreements hope to achieve one of these two goals, and some hope to achieve both goals at the same time. Recently, there are a wide variety of DeFi projects that have issued tokens. There are decentralized exchanges and currency markets. No matter what kind of projects, they have adopted a liquid mining model. These projects have one thing in common, that is, they have accumulated a group of early users to actively participate in the agreement governance work, which has brought great value to the development of the project.
This article will discuss the advantages of liquid mining and how DeFi projects can inject liquidity into the platform and improve the token distribution mechanism through this innovative financial model. One thing to point out here is that this article only discusses the value proposition of liquid mining without evaluating its right or wrong.
Inject liquidity into DeFi applications
Initially, the role of liquidity mining was to directly inject liquidity into a certain type of DeFi asset. The first to engage in liquidity mining was Synthetix, which is a decentralized derivatives protocol that connects to Chainlink to feed prices. Synthetix launched a liquidity mechanism in mid-2019 to issue rewards to users who provide sETH/ETH liquidity on Uniswap. Users pledge the tokens in the Uniswap sETH/ETH liquidity pool in the contract and obtain SNX tokens (ie Synthetix’s native tokens) in proportion.
In fact, this not only allows liquidity providers to obtain additional benefits other than transaction fees (and reduces impermanence losses), but also lowers the threshold for traders to enter the Synthetix ecosystem, because they can easily convert ether into sETH (Note : Synthetix’s Ethereum synthetic assets), and greatly reduce transaction slippage. After users have exchanged sETH, they can enter the Synthetix ecosystem and start buying other synthetic assets. These synthetic assets usually include commodities, fiat currencies, cryptocurrencies, and indices. Although this model did not last, Synthetix later introduced more incentives to stimulate the liquidity of other synthetic assets, including sUSD and sBTC.
As mentioned above, Synthetix is a pioneer in liquid mining, and the current innovation leader in liquid mining is none other than Compound. Compound issued its own governance token in June 2020. Since then, liquid mining has seen explosive growth and a variety of dazzling innovative applications in the DeFi field. With the continuous innovation of many projects, the effectiveness of various liquid mining mechanisms has also been verified, and more complete mechanisms have been iterated.
Liquid mining is continuously developing in the following areas:
- Choose different types of DeFi tokens for pledge to attract different token communities.
- Support multiple liquidity pools (eg Uniswap and/or Balancer)
- The proportion of pledged liquidity pool shares is different (for example, 98/2 vs 50/50)
- Incentive mechanism for certain liquidity pools (Note: Incentive users to deposit a certain token)
- In addition, there are many other innovative mechanisms
This wave of innovation has spawned a large number of decentralized applications, each with a unique value proposition, and iterative innovation on the original basis.
At present, the DeFi community divides each liquid mining pool into two categories, namely pool 1 and pool 2. Users in pool 1 can pledge various types of tokens (such as ether and stable coins) that have been traded on the secondary market. In the second pool, the governance token of the platform must be pledged, which can directly stimulate the liquidity of this type of token and give users the opportunity to obtain income. With the rapid development of DeFi, we will see the field of liquid mining continue to innovate, and the value of its realization will also increase.
The meaning of liquidity and its network effects
Before discussing why the DeFi protocol is willing to issue tokens to users, we must first clarify the importance of liquidity to the DeFi protocol. Decentralized applications are completely open source, so the funds deposited by the community and users have become the most important protective barrier for the agreement. A successful DeFi protocol must not only focus on its business logic, but also establish a lasting network effect. The network not only includes the code itself, but also includes various factors such as application scale, user groups, community support and the value it generates.
Therefore, the DeFi protocol began to use liquidity mining to directly inject liquidity into it, thereby enhancing user experience and application scale. The increased liquidity of DeFi applications (ie: the supply side) has also led to an increase in the scale of users (ie: the demand side). Users pay fees to liquidity providers, which also attracts more capital inflows, thus creating a virtuous growth cycle. The purpose of this cycle is to help the DeFi protocol continue to absorb liquidity and stand out from the competition. Users and liquidity providers will naturally tend to the platform with the lowest slippage and the highest return, which will produce a clustering effect.
Liquidity here is like a moat, guarding the security of the DeFi protocol, but this moat is not completely insurmountable. Liquidity mining can be used as an incentive to attract liquidity from other protocols, which may have a “reversal” effect, which means that once enough liquidity is transferred to the new protocol, the network effect will follow. Transfer over. This is also known as “vampire mining”. Although it is not yet known whether this method will work in the long run, we can see that liquid mining is not only of great significance to the agreement, but also can be a nirvana for launching liquidity wars. After all, liquid mining is just a tool that can achieve different goals.
The platform issues tokens as rewards to users who mine through liquidity, in order to encourage them to keep their funds on the platform. In addition, users can also obtain a portion of the transaction fees generated by the DeFi application, and will actively participate in governance work related to the future development of the agreement, such as voting to add a new liquid mining pool. In order to ensure that the governance of these DeFi applications is truly decentralized, the distribution of tokens needs to cover various independent users, which involves the second purpose of liquid mining.
Fairly distribute tokens and build stakeholder communities
Although the original purpose of liquidity mining is not to distribute tokens fairly, it can indeed achieve this purpose. Tokens will be issued directly to the community in a fair manner, rather than left to a small number of investors and insiders. The number of tokens issued is proportional to the user’s specific financial contribution. This model puts the governance of the agreement in the hands of the community, and makes changes or additions to the agreement in a democratic way.
The project uses a liquid mining mechanism to achieve fair distribution of tokens, and to ensure that tokens can not only be distributed among multiple parties, but can also be directly distributed to users who contribute value in the ecology. In this mode, an extremely powerful community of token holders can be established, and community members can obtain great incentives to jointly promote the development of the agreement and increase the value of the token. If stakeholders get incentives, they are more likely to stay on the platform and continue to contribute value.
One of the most typical examples is YFI, which is the original token of yEarn Finance. yEarn is a smart contract protocol whose purpose is to discover the best revenue opportunities for users at the moment and automatically configure liquidity in DeFi applications. In July of this year, yEarn publicly issued 30,000 YFI tokens to liquidity providers in multiple liquidity pools within two weeks. At that time, the concept of liquidity mining just came out. The people who dig into YFI basically have a deep understanding of the DeFi ecology. These people came together to build the YFI community. Later, these YFI tokens were invested in many other DeFi applications, which shows that users not only hold the tokens, but also actively use the tokens in their hands to further enhance the overall liquidity of the yEarn ecosystem.
Once the token can be issued fairly, the future development of the agreement will be directly linked to the economic incentives of community members. Therefore, the community will spontaneously form a democratic governance mechanism to further promote ecological growth. yEarn’s liquidity mining mechanism has injected a lot of liquidity into yCRV (note: this is a basket of stablecoins that earn revenue on yEarn). At the same time, YFI’s fair distribution mechanism contributes to yEarn’s current and future success. It’s indispensable, and even said it had a greater impact. In short, liquidity mining allows yEarn to bring value to any DeFi protocol in two important dimensions at the same time, namely: 1) improve the liquidity of the user side and establish network effects; 2) build a strong community and promote The agreement moves forward.
Chainlink helps liquidity mining
Smart contract developers can also use other infrastructure to further improve the performance of liquidity mining in the two dimensions of incentive mechanism and fair distribution of tokens. One of the solutions is the Chainlink oracle. Developers can access the mainstream Chainlink price feed mechanism. The price feed is based on the Chainlink decentralized oracle network. Many liquid mining projects have begun to access Chainlink to feed prices. There are still many untapped application scenarios in this field, which are worthy of continuous exploration.
- Token lock-up—— Plasm is a protocol based on Polkadot, which allocates tokens to liquidity providers based on two dimensions, namely: 1) the value of pledged assets when the reward is issued; 2) the pledged assets are locked in the agreement time. The purpose of this mechanism is to encourage users to provide long-term liquidity to the platform.
- Liquidity pool rewards are distributed proportionally-the DeFi protocol StrongBlock connects to Chainlink to calculate the total dollar value of pledged assets in the multi-asset pool and distributes rewards proportionally. This mechanism allows StrongBlock to expand the size and asset class of its liquidity pool, and users who provide more liquidity will receive more rewards accordingly.
- Reward automatic adjustment -you can access the Chainlink feed price to transmit the market price of the liquid mining token to the chain. This mechanism has unique application potential. For example, it can automatically adjust the issuance of tokens according to market prices, which will help stabilize users’ liquidity mining income. Other dApps can also connect to Chainlink to quickly develop innovative DeFi financial products and support liquid mining tokens. For example, Chainlink released YFI/ETH price feed, financial derivatives that support the Opium protocol.
In addition, developers can also explore countless other application scenarios.
to sum up
Liquidity mining is an innovative application scenario in the DeFi field, which can realize value in two dimensions, namely: 1) Provide incentives to inject liquidity into applications; 2) Realize fair distribution of tokens. Various stakeholders in the DeFi field are also taking advantage of liquidity mining to reduce the transaction slippage of token exchange in DeFi applications and successfully establish a united and strong community. If it were not for the emergence of liquid mining, these would not be possible. Liquidity mining has also helped countless projects to accelerate the growth, and the amount of locked positions currently reaches hundreds of millions or even billions of dollars.
We do not yet know how liquid mining will develop in the future, nor whether the current model can support long-term growth. However, it is certain that innovation in the DeFi field will not stop. Liquid mining, as a financial model, may undergo some changes, but it will definitely continue. With the continuous development of DeFi, Chainlink will continue to provide developers with the required decentralized oracles and develop a variety of practical decentralized applications, which of course also includes liquid mining.
