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November 13, 2024

Demystifying Liquidity Mining: A Straightforward Guide

In the early days of cryptocurrency, “mining” referred exclusively to using computational power to solve complex problems on proof-of-work (PoW) blockchains, creating new coins in the process. While PoW mining remains central to assets like Bitcoin, crypto enthusiasts now have an alternative for earning rewards directly into their wallets: liquidity mining.

Liquidity mining has become a key component of decentralised finance (DeFi), driving billions of dollars in digital assets into decentralised applications (dApps). and allowing crypto holders to earn passive income from their tokens by placing them into liquidity mining protocols, receiving token rewards over time.


In this guide, we’ll break down the essentials of liquidity mining, explaining how it works, how it compares to staking and yield farming, and the potential benefits and risks involved.

Understanding Liquidity Mining

Liquidity mining is a mechanism within the DeFi space that encourages users to provide liquidity to decentralised exchanges (DEXs) in exchange for rewards. By contributing assets to a pool, participants enable smoother and more efficient trading for others, and in turn, their contribution is rewarded, offering a fair value exchange for all parties involved.

How Does Liquidity Mining Work?

DEXs with liquidity mining opportunities, such as Uniswap, often use an algorithmic framework called an automated market maker (AMM) model to confirm peer-to-peer (P2P) swaps without centralised authorities. In the AMM system, liquidity providers lock their crypto assets into programs called liquidity pools.

Think of liquidity pools as virtual vaults containing all the deposited digital assets from liquidity miners. They run on self-executing coded commands called smart contracts on their respective blockchains to ensure there's no risk of centralised counterparty interference.

Whenever DEX traders swap the crypto pair in a liquidity pool, they pay fees, which flow to participating LPs proportional to their contribution. For example, if a liquidity miner deposits 1% of the total amount in the ETH/AVT pool on Uniswap, they earn 1% of the total fees collected for every ETH/AVT swap.  

How does Liquidity Mining Differ From Crypto Staking?

Cryptocurrency staking is another popular passive income strategy in Web3, where traders lock funds in smart contract vaults and earn rewards in their wallets. However, participants can’t interact with DeFi dApps and let other traders use their funds for P2P swaps. Instead, stakers earn rewards by contributing to a proof-of-stake (PoS) consensus algorithm.

While stakers and liquidity providers both earn passive crypto rewards for depositing their digital assets, the staking supports a PoS blockchain's infrastructure, while the liquidity mining adds features to the DeFi ecosystem.

Benefits of Liquidity Mining

  • Legit and self-custodial passive income strategy: Liquidity mining provides traders a straightforward way to earn money on their digital assets. Plus, since liquidity mining takes place in the DeFi ecosystem, LPs don't have to entrust their tokens to a centralized entity and deal with counterparty risk.
  • Global accessibility to market maker fees: Traders don't need special accreditations or high capital requirements to participate in market making and earn fees from crypto trading activity. Eligible traders with crypto and a digital wallet have all the tools they need to start earning funds.
  • DeFi ecosystem support: Without deposited funds in DeFi liquidity pools, there wouldn't be a way to exchange crypto assets without trusting third-party intermediaries. Liquidity mining is a powerful incentive system to support the decentralized economy and attract funds to DEX protocols.

Risks of Liquidity Mining

  • Impermanent losses: Impermanent losses mainly occur in AMMs as their mechanism is used to maintain a liquidity balance among the tokens in the pool. If the price of tokens in the pool changes significantly after you provide liquidity, the platform's automated system may rebalance the pool by buying more cheaper tokens and selling more expensive tokens. This rebalancing action could result in losses for yield farmers.
  • Smart contract flaws: DeFi protocols are built on smart contracts. Hackers can exploit any errors or vulnerabilities in the code, resulting in the loss of deposited funds.
  • Interest rate fluctuation: Yields change based on supply and demand dynamics, which makes it difficult to predict potential future returns. For example, as more people offer assets, yields may collapse.
  • Price fluctuation: Cryptocurrency prices can fluctuate significantly, affecting rewards and the value of your deposited assets. If the value of the tokens you earn rewards for drops significantly, all of your profits may be eroded.

Liquidity Mining with Aventus

One of the biggest limitation of not only most liquidity mining platforms, but decentralised apps in general, is that have historically struggled with user experience (UX) when compared to Web2 apps.

With the new Aventus dApp, liquidity mining has been streamlined. This interface allows AVT token holders to participate in liquidity provision without needing to navigate the complexities often associated with DeFi platforms. Users simply connect their wallet, select the amount of AVT they wish to contribute, and the dApp guides them through the steps required to provide liquidity to the AVT-ETH pool on Uniswap.

FAQ

How can I participate?

The Aventus dApp’s design prioritises simplicity and security, ensuring that participants have a smooth experience while supporting the stability of the AVT ecosystem:

  • Add liquidity to the AVT/ETH pool on Uniswap, here.

You can find full instructions on how to add liquidity below:

  • In return for adding liquidity, you'll get a Uniswap NFT (NB: you can trade this NFT back to extract your liquidity back out).
  • Stake your Uniswap NFT in the Aventus dApp to begin earning rewards for providing liquidity.

How are rewards distributed?

There is a total pool of 9,000 AVT available for rewards, which are accrued based on the amount of liquidity provided and the trading activity within the pool.

Rewards are distributed on a monthly basis for the duration of the liquidity mining program,which will run for three months.

At the end of each month, liquidity providers will have three options:

  1. Unstake and collect rewards: receive your earned AVT to your wallet and have your NFT returned to you. You can then go back to Uniswap to trade your NFT to receive your liquidity pool back.
  2. Collect rewards: simply receive your earned AVT to your wallet, and retake your NFT again for the next round.
  3. Compound: retake your original pool and your earned rewards into the next round. You will be promoted to also add the required amount of ETH to match the extra AVT being staked.

What if I want to get my liquidity back before a round ends?

There is no unbonding period, meaning you can get your liquidity back at any point with the 'exit early' option. You will receive your NFT back, which you can use to get your liquidity back from Uniswap. However, if you do this before the end of the round, you will forfeit your rewards.

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