Liquidity Mining: What Are the Key Pros & Cons?

Many crypto experts compare the DeFi hype caused by liquidity mining with the ICO hype in 2017. But the main difference is that DeFi platforms already have fully functioning products and services.

The ICO tokens from 2017 usually only gave rise to so much hope that one day a groundbreaking product will be available. Almost no ICO project was able to fulfill the promises described in a whitepaper. Many useless ICO tokens stand opposite DeFi governance tokens, which authorize the protocol coordination of extensively used projects.

The main difference is that DeFi projects reward their participants for the use of functioning apps and don’t require pre-financing for the realization of future projects. Compared to ICOs, this is also a new way of putting tokens into circulation. In addition, it offers users a chance of high returns and a lucrative passive income.

Key Pros of Liquidity Mining: Main Benefits

Liquidity mining is a win-win situation for projects and their participants. The main beneficiaries are decentralized file-sharing exchanges (DEX) and lending platforms, which experience even higher demand as a result. But are there other winners as well?

The increased demand for liquidity mining in DeFi apps inevitably leads to an increasing demand for smart contracts. As a result, the demand for smart contract insurance such as Nexus Mutual or Opyn is expected to increase. The enormous growth in DeFi apps and governance tokens will increase the need for clear data aggregators and dashboards.

Ultimately, Ethereum miners will also benefit from the increased use of liquidity mining. If there is no capacity expansion, more transactions ultimately increase the fees.

Liquidity mining offers the following advantages for DeFi projects:

  • Providing high liquidity to platforms to ensure initial growth;
  • Increases loyalty to a community;
  • Attracting attention — positive marketing effect for a project;
  • Intelligent and fair distribution of tokens promotes decentralization of a project;
  • Very little regulatory effort.

Key Cons of Liquidity Mining: Main Risks

As with almost everything, there is also a dark side of liquidity mining. Before participating, one should analyze all potential risks and disadvantages. 

As part of decentralized finance, liquidity mining is subject to the following general risks:

  • Technical risk: Smart contracts could be hacked or vulnerabilities could be exploited. 
  • Admin key risk: A master private key for a protocol could be compromised. 
  • Use risk: Improper use of DApps can lead to financial loss.
  • External risk: Unforeseen external events (Black Swan Event) can have various negative influences.
  • System risk: The security and capacity of the blockchain, i.e. the basis for transactions, isn’t guaranteed.
  • General financial risk: Economic incentives can be lost for a variety of reasons and expected returns may not materialize.
  • Regulation: There is currently almost no regulation at DeFi. Therefore, projects that require more regulation suffer a considerable disadvantage. But regulation is only a matter of time which could have a huge impact on the entire DeFi market.

If you want to read more articles relating to this topic, please let us know in the comments. Feel free to share your opinion there!

Leave a Reply

Your email address will not be published.