Crypto Basics #10: What is Yield Farming and Liquidity Mining?

By 2sats | 2sats | 26 Jun 2022

*obligatory not financial advice*



In this series I want to explain some terms that are relevant to the amazing world of cryptocurrencies to help newcomers understand it better. Today I want to talk about Yield Farming and Liquidity Mining.


Previous Parts:

Crypto Basics #1: What even is a Blockchain?

Crypto Basics #2: What are Smart Contracts?

Crypto Basics #3: What is a Cryptocurrency Wallet?

Crypto Basics #4: What is Mining and Proof of Work?

Crypto Basics #5: What is Staking and Proof of Stake?

Crypto Basics #6: What is Decentralized Exchange? And how do they work?

Crypto Basics #7: What are Stablecoins? And How do they work?

Crypto Basics #8: What are Coins and What are Tokens?

Crypto Basics #10: What is Yield Farming and Liquidity Mining?


What is Yield Farming and Liquidity Mining?

There are countless of different dApps across all blockchains available that allow their users to earn cryptocurrencies thru various methods. For example there are lending protocols that allow their users to lend or borrow different digital assets and there are decentralized exchanges that make it possible to trade cryptocurrencies or earn a yield by providing them.

Such dApps often have governance tokens that give their holders voting rights for possible changes and since the dApp is only truly decentralized if the supply of the governance token is well spread there are methods to let users earn a share of the supply. This distribution is called Yield Farming or Liquidity Mining.

The exact mechanics of a distribution and tokenomics are different for each token, but it usually requires the users to provide liquidity to the protocol there is typically a fixed amount of tokens distributed every day, so how many tokens you can earn depends on how much liquidity you provide vs how much liquidity everyone else is providing.

One method of distributing a token is to give it to users as additional reward. Lending Protocols, like Compound and Aave, usually do this by distributing their own governance token as additional reward to people that supply funds to earn an APY via lending and often also to borrowers. Because of that it is technically possible to earn more crypto thru borrowing than what your interest rate costs you, but this is usually not sustainable for the long term because everyone would take advantage of this which makes the reward APY fall. Yield Optimizers, like Yearn and Devil Finance, are also distributing their tokens to people that supply liquidity.

The most common way to distribute tokens is by rewarding liquidity providers for certain trading pairs. Decentralized exchanges work by letting their users provide funds to trading pairs, in exchange they get LP-tokens that represent their share of the provided funds. Often the liquidity providers can stake their LP-tokens to earn an additional yield. This is how most decentralized exchanges distribute their tokens, but other protocols can also distribute their tokens that way.

There are also a few more exotic ways of liquidity mining. For example, some projects also distribute their tokens with special pools where people can stake their token, or the token of a partnered project, to earn even more tokens. Some dApps even have features that allow other projects to set up such pools, like PancakeSwap and SpookySwap.

The terms "Liquidity Mining" and "Yield Farming" are synonymous, but farming is more often used in the context of providing liquidity to a DEX and staking the LP-tokens and liquidity mining is more used for anything else.


I hope that short explanation was helpful for some newcomers. I will keep writing more such short articles about various crypto terms. Feel free to follow me if you are interested.




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