What Is Liquidity Mining?
Liquidity Mining is a process in which participants contribute cryptocurrencies to liquidity pools and receive rewards in the form of fees and tokens based on their share of the total pool liquidity. These pools consist of liquidity in pairs of coins or tokens and can be accessed through Decentralized Exchanges (DEXs).
In traditional finance (TradFi), brokerage houses and firms act as market makers, providing buying and selling solutions for investors. They are compensated for the risk they take in holding assets to provide liquidity to the market and earn profits through the spread between the bid and offer price of an asset. For instance, if a stock has a bid price of $100 and an ask price of $100.20, the market maker purchases the shares for $100 and sells them for $100.20, making a profit of $0.20.
Unlike TradFi exchanges, DEXs are always available for trading through the use of Automated Market Makers (AMMs) and liquidity pools. A basic liquidity pool creates a market for a specific pair of assets on a DEX, such as UDSC/RIN. When the pool is created, a liquidity provider sets the initial price and proportion based on the market to ensure an equal supply of both assets. This equal supply concept remains the same for all other liquidity providers who want to contribute liquidity to the pool.
Liquidity providers are incentivized based on the amount of liquidity they contribute to the pool. When a trade occurs, the transaction fee is distributed proportionally among all liquidity providers. Smart contracts govern the operations within the liquidity pool, and each asset swap facilitated by the smart contract results in a price adjustment.
Author Bio: Hisham Khan, CEO of Aldrin
Hisham Khan has a background of over a decade in managing and developing robust and innovative financial and enterprise technology. With extensive experience at Bloomberg and based in New York, Hisham has worked as a project manager alongside some of the world’s top engineers. It was during this time that he recognized the transformative impact of cryptocurrencies, leading him to leave Bloomberg and create comprehensive and accessible trading tools through Aldrin. His main mission is to make advanced crypto trading and strategy development accessible to everyone.