With more and more cryptocurrency platforms offering attractive returns of more than 1,000%, an old and highly irritating phrase is sure to be on the lips of regulators, financial institutions, ordinary investors, and now billionaires, and if it looks too good to be true, it probably is. We’re talking about the world of liquid mining and pledging. Let’s explain what these terms mean and look behind them to assess whether liquidity mining and/or pledging should be legitimate investments for investors to look at. Pledges Pledges are a mechanism derived from the Proof of Interest consensus model, which is an energy-driven alternative to the Proof of Work model where users mine cryptocurrencies. Both centralized and decentralized exchanges allow users to invest in their assets without having to deal with the technical issues of setting up nodes. The exchange in question will handle the verification part of the process itself, while the pledger’s only job is to provide the asset. The main purpose is not to provide liquidity to the platform, but to ensure the security of the blockchain network by making it more secure. The more users pledge, the more fragmented the blockchain becomes, and thus harder to attack. Although pledge is often associated with proof-of-stake networks, it has taken on a life of its own. Many crypto projects have used pledges as a way to create “stickiness” on their platforms. By providing a way for users to earn income by holding tokens, it prevents them from moving their money to another platform, anyway, that’s the theory. There is, of course, another effect of high returns. They encourage investors to buy tokens, leading to scarcity and pushing up prices. Pledged income is provided in the form of interest paid to the holder by the token. Rates vary from network to network and platform to platform, depending on several factors including supply and demand. The return on a cryptocurrency pledge is not without risk, as multiple factors can affect the performance and security of the pledged token. The first risk is the possibility of a cyber security incident leading to the loss of the held tokens. This happened recently with Pancake Bunny, a once-successful project that saw prices plummet by more than 90% after a massive attack. Another risk of a pledge comes from a potential fall in the price of crypto assets during the pledge period. Because the pledge is made by locking up tokens, investors will not be able to liquidate their holdings in the event of a market fall, leaving them at risk of losing part of their principal and not being able to sell to mitigate their losses. Liquidity mining Liquidity mining is the practice of pledging or lending cryptocurrency assets to generate high returns or returns in the form of additional cryptocurrencies. The use of such decentralized finance has recently become very popular, thanks to a variety of innovations. Liquidity mining is currently the biggest growth driver for the DEFI industry. In short, liquidity mining incentivizes liquidity providers (LPs) to hold or lock up their crypto assets in a smart contract-based liquidity pool. These incentives can be a percentage of transaction fees, interest from the lender, or governance tokens. As more and more investors put money into the relevant liquidity pool, the value of outstanding returns rose. Liquidity mining occurs when a Liquidity Mining participant is rewarded with tokens as an additional compensation and becomes prominent after Compound publishes its COMP governance tokens to users of its platform. Most liquidity mining protocols now reward liquidity providers with governance tokens, which can typically be traded on centralized exchanges such as Binance and decentralized exchanges such as Uniswap. There is some crossover between equity investing and liquidity mining by introducing governance tokens and moving away from certificates of equity. Risks of Liquidity Mining Liquidity mining typically requires higher Ethereum gas fees, but with the popularity of Binance smart chains and their lower gas fees, the opportunities for investors have increased. Users are also exposed to greater risk of volatile losses and price declines when markets fluctuate. Liquidity mining is vulnerable to hacking and fraud because of potential vulnerabilities in the protocol’s smart contracts. These coding errors may occur due to intense competition between protocols where time is of the essence and new contracts and features are often unaudited or even copied from competitors. Increased risk protocols for issuing meme tokens that provide thousands of APY returns. A lot of these liquidity pools are scams, where the project side pulls all the liquidity out of the pool and disappears with the money. Defi- Decentalized Finance – Decentalized Applications – DAPP Impermanent Losses A temporary loss occurs when an investor provides liquidity to a pool and the price of the assets held changes from when they were deposited. The greater the change, the greater the loss of impermanence. Pools containing assets, such as stablecoins, have fewer volatile losses if the price range is relatively narrow. Impermanent losses can still be offset by trading costs. For example, pools exposed to volatile losses on Uniswap can be profitable because of transaction fees. Uniswap charges a 0.3 per cent fee for each transaction that goes directly to a liquidity provider. If the volume of trading in a particular pool is high, it is profitable to provide liquidity even if the pool is exposed to severe and volatile losses.
Risk means that risk is relative. The risk assessment on this table is based on the relative risk of holding cryptocurrencies as investments. As an investment, cryptocurrencies are risky. For example, the risk of pledging through Coinbase is low compared to investing in newly minted memes, but it is still high compared to other investment classes. Another important point to note is that while a platform may be rated low risk, investors must remember that the higher the return on offer, the higher the risk. In other words, a low-risk platform can offer high-risk investments. Pledge and liquid mining used to be two different worlds. In recent times, however, the two definitions have tended to merge. While liquidity mining focuses on earning the highest possible return with the goal of creating liquidity, the purpose of pledging has expanded from helping the blockchain network stay safe to pledging tokens on a given platform to earn a return. Before investing through any pledge or liquidity mining platform, you must assess the volume and liquidity of the pledged tokens. Liquidity is necessary. You must also consider whether the project has more depth than a simple pledge platform. Recently, there have been a number of meme-type projects that offer coveted returns but no fundamentals. [This article was compiled and published by qkljys123.]