Understanding market liquidity
Before engaging in liquidity mining, it is important to know what lies behind the purpose of liquidity and how it works.
Liquidity basically refers to the liquidity of a fund, marked as the ability to buy and sell assets without creating sudden changes in the market price of the asset. So, here are some key elements on how a new coin or crypto exchange works. Furthermore, they are based on a few parameters, including speed, spread, transaction depth, and usability.
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Transaction speed
For example, if liquidity is low, there is a high possibility of delays and limit orders can take hours or even days to process and execute. On the other hand, order processing takes only a few seconds for highly liquid pairs.
Bid-ask spread
The bid-ask spread is recognized as one of the key strengths of market liquidity. Reveals the variance between the selling price and the bid price of an asset. The narrower the spread between buy and sell orders, the more liquid the market will be.
transaction depth
The greater the depth, the smaller the significant impact of a particular number of trades on the price.
Usability
Usability is also a determining factor. The more often a cryptocurrency is used as a payment method , the more liquid it becomes. Consequently, if more merchants start accepting cryptocurrencies as a means of payment, it will contribute to further adoption and use of cryptocurrencies in transactions.
What is liquidity mining?
DeFi has been a resounding success and has seen a surge in activity and public interest. Liquidity mining is rightly considered one of the key components of this success. In addition, it is considered a useful mechanism to boost liquidity.
Generally speaking, liquidity mining occurs when users of a specific DeFi protocol profit from that protocol’s native tokens to join the protocol. It is the method of storing or lending detailed symbolic assets to liquidize the product pool and receive an income afterwards.
Thus, a liquidity miner can receive rewards served by a project’s native token or even the governance rights it represents. But, tokens are usually created based on protocol programming. However, most of them cannot be used outside of the DeFi platform responsible for generating them.
Furthermore, the creation of the exchange markets and the hype around those tokens contribute to an increase in their value.
Also, DEXs are always in the attention of new users who can contribute capital to the platform and reward them for their contributions. Currently, most of the DEXs are renewing their order books with AMMs that offer efficient regulation of all trading procedures. Additionally, AMMs offer token swapping which forms their potential to trade one token for another within a distinct liquidity pool.
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Similarly, when users choose to manage a trade, they are supposed to pay a certain fee. The AMM collects the fees and gives them to each liquidity provider as a reward. Therefore, the token exchanger can trade on a DEX if they pay a fee. Furthermore, the liquidity provider manages to make money by providing the much sought after liquidity that the user needs.
Capabilities and benefits of liquidity mining
Although liquidity mining has broken into the world of cryptocurrencies very suddenly, it has already shown itself to be a game-changing tool, capable of performing multiple functions, which we will review below.
Overall liquidity improvement
The liquidity of the funds is considered the vital element of the liquidity of the entire economic system. But sadly, DeFi does not have a self-built capital pool that provides solid liquidity to other specific industries.
As a result, creating a viable and innovative decentralized pool model and general user incentives through an interest rate mechanism that would add better liquidity has become a well-thought-out primary goal of DeFi projects.
Price discovery promotion
Due to the ultra-fast growth of blockchain technology , several separate entities have been realized, Uniswap clone software in which liquidity mining can be brought together in a decentralized dimension. Therefore, the method can also speed up the frequency of securities trading and better price discovery.
To clarify, price discovery shows the traders’ knowledge of the relevant market supply and demand situation. But also the expectations of future market opportunities. Therefore, liquidity mining can allocate resources and allow investors and different financial firms to make fairer pricing decisions.
Most effective marketing strategy
Liquidity mining is useful when generating a lot of press coverage and generating greater awareness of the product. First, though, you need to manage all of the momentum properly to ensure that the liquidity mining budget isn’t spent on this goal alone.
Wider and fairer distribution along with lower barriers to entry
One of the vital benefits of liquidity mining is that small retail and institutional investors have an equal opportunity to own tokens native to a specific protocol. Furthermore, this is a valuable benefit for investors who previously wanted but did not have the opportunity to participate in the DeFi ecosystem.
Types of Liquidity Mining Protocols
Liquidity mining protocols come in all shapes and sizes. Each protocol is strange and offers its unique characteristics and types of reward agreements. However, you are marking most of the protocols in three different groups.
Furthermore, those groups vary according to their purpose, method of decentralization, and distribution. However, it depends on what you are looking for in a project. Also, you can choose a specific group based on your needs.
● Fair decentralization protocols
Fair decentralization and liquidity mining projects often try to reward aggressive community members; however, they do spread governance tokens to all early adopters who joined the platform most of the time. By doing so, the developers ensure decentralization by allocating tokens that do not involve a token sale or market listing.
● Progressive decentralization protocols
Progressive decentralization protocols are doubtful to transfer control of the platform to society directly. As a result, developers typically do a governance model months after the platform’s initial launch. Similarly, the token is rarely listed on the market before developers use online governance. Therefore, the main goal is to ensure a fair allocation of tokens to prevent whales from farming high governance tokens.
● Marketing-oriented protocols
Marketing-oriented protocols describe a type of liquidity extraction protocol that is fueled by advertising. The project is often revealed weeks before launch and they offer users incentives to market the platform. That way, the developers lead a large user base before the launch of the platform. Additionally, trading a platform can help raise funds for liquidity, which is often locked up by developers for long periods.
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