Liquidity Mining Versus Yield Farming: An Easy-to-Understand Guide

You’ve probably seen the word ‘HODL’ everywhere on Crypto Twitter and in community groups. If you believe a project has huge potential, HODLing will come easy to you. That said, why not also gain some benefits at the same time?

With the emergence of decentralized finance (DeFi) and DeFi tokens, there is a proliferation of yield farming today as projects attempt to incentivize token holders to invest in their ecosystems.

Yield Farming

Put simply, yield farming is an investment strategy to maximize your existing crypto assets and generate the most returns possible. If you want to earn passive income from your tokens, yield farming will help you to ‘grow’ your crypto.

• Includes staking, lending, liquidity mining, and more

• Traders lock up or provide their crypto to the project to be used.

• In return, they earn from transaction fees and token rewards.

• Many projects give out rewards in the form of more tokens

Staking

Staking happens when you commit your crypto assets to support a blockchain network and help verify blockchain transactions. Your staked crypto is used to support a consensus mechanism called ‘Proof of Stake’ to ensure transactions are secured and verified.

Traders earn from block rewards i.e., tokens are minted and distributed every time a new block is added to the blockchain.

Lending

In crypto lending, you are able to use crypto assets as collateral to receive a loan in stablecoins. Most crypto loans have to be overcollateralized, meaning that you have to lock up more assets than the value of stablecoins you are receiving. This is due to the price volatility of crypto.

Your crypto will be returned to you once you have repaid the loan plus interest. If the price of your crypto asset increases, you will have made a profit by the time you repay the loan.

Liquidity Mining

Liquidity mining occurs when liquidity providers supply tokens into a pool of crypto assets. In liquidity mining, a pool with an equal value of two tokens is created. For example, if you are supplying tokens to a BTC-USDT pool, you’d need to have both BTC and USDT.

Pools are then used to provide liquidity to the project or commonly, to decentralized exchanges (DEXs).

In return, providers can earn incentives, usually in the form of the project’s native token or one of the two tokens in the pool.

Do note that one main risk of liquidity mining is impermanent loss. When people trade much more on one side of the pool versus the other, you can end up with an imbalance. The price of your deposited assets may change as compared to when you first deposited them.

Losses are likely to be equalized with high annual percentage rates (APRs), which tell you your expected returns. However, you should know that APR rates are dynamic and can fluctuate. Always do your due diligence, and confirm the rates before allocating your funds to the pools. You will also need to monitor the rates regularly to ensure you reap the best rewards.

Conclusion

Yield farming helps make your crypto work for you. With yield farming, you can grow your crypto instead of leaving them dormant in your wallet.

Liquidity mining is one method of yield farming. You can earn from supplying crypto assets to a liquidity pool. Other forms of yield farming involve staking and lending.