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Author: Gianmarco Guazzo
For fans of the cryptocurrency and blockchain world, 2020 is definitely the year of DeFi: Believe it or not, the number of retweets and likes on this topic has continued to rise in recent months. According to some accounts, DeFi is only the innumerable bubble in this budding world. In this world, FOMO, promises of high returns, and the use of unreal governance tokens are declining. As analyzed in some articles, DeFi is undoubtedly a large pool. From DEX to synthetic assets through lending platforms and asset management platforms, we have found countless strategies, terms and projects in the most diverse fields.
In this article, we try to explain and distinguish two terms that are often confused and used, namely Liquidity Mining and Yield Farming.
Liquidity mining: earn Token by giving liquidity
Liquidity mining originates from two very important concepts in the cryptocurrency world, namely liquidity and mining. The so-called liquidity, we refer to the availability of tokens in a given platform, which is essential for the creation, growth and expansion of the DeFi market. As for mining, we refer to PoW-based technology. By providing computing power, you can obtain new coins just minted by the algorithm. Although these two concepts are far apart, they can be combined with each other, which is undoubtedly beneficial to the vigorous development of some DeFi projects.
Generally speaking, people who want to participate in liquidity mining “lend” liquidity to a certain pool (for example, on Uniswap), and obtain the newly minted token based on the time and amount of liquidity provided. Let us give an example to explain the possible doubts.
A new platform in the DeFi world is the governance token (GOV). If it wants to distribute Tokens and in order to do so, the platform will introduce some Uniswap pools on its white paper or landing page, and then use liquidity mining to “mine” these GOVs from these pools.
- Those who are interested in the project or who may receive these GOVs must provide liquidity to the aforementioned pools.
- In exchange, users will receive the liquidity provider Token (LP Token) required for the final redemption.
- As long as the Token provided by the user is still in the pool, he can earn 0.3% of the handling fee and the governance Token for “mining” in each block at the same time.
- At the time of redemption, the user obtains both the handling fee and the “mining” GOV by returning the LP.
Simple solution for liquid mining
You can easily guess that this process created a real gold rush among DeFi users. At the same time, we also want to thank Yield Farming. It is a good opportunity not to be missed to obtain “free” tokens by providing liquidity to a pool. So, what is Yield Farming and how does it use liquidity mining?
Yield Farming: Through the automatic transfer of funds, to maximize returns
Yield farming is a simple process on top of liquid mining. It uses its main features to maximize user benefits. In essence, yield farming is the use of multiple mechanisms such as liquidity mining, fund leverage, and risk selection to move its liquidity among various DeFi platforms.
On June 16, Compound began to issue governance tokens to users, and the idea of yield farming was born. Users accumulate COMP by “borrowing” and “buying” stablecoins, and then distribute them. After this idea and the rapid increase in the value of COMP Token, any project in the DeFi world wants to create its own Token and distribute it to incentivize users to trade on a certain platform. Therefore, liquidity mining and profitability farming are carried out at the same time: by earning governance tokens, transferring their own stable coins, etc., to maximize returns.
Soon after, many platforms promised very high APY (annualized rate of return), but it is almost impossible for an individual to find the project with the highest return within the known time. So there are projects like yearn.finance, a platform that automatically manages funds through risk selection and is used for yield farming.
What do you think of these two strategies? Do you think DeFi is an industry worth watching?