Pharming or liquidity mining is one of the ways to passively earn money in the decentralized finance sector, which involves the use of automated smart contracts. The user leases his crypto assets to a certain liquidity pool, and for this he receives a certain reward. It sounds extremely simple, but in reality everything is much more complicated.
What is Mining?
The idea of decentralized finance is now at the forefront of blockchain innovation. This is what makes it almost completely decentralized and the ability for anyone to participate in financial exchange processes - there would be access to the Internet and a cryptocurrency wallet. At the same time, there are no custodians, no intermediaries, no external regulators - the system is set up and works automatically - due to well-thought-out smart contracts. But for all this to be possible, you need someone who will form the liquidity pools. This is exactly what the passive earnings strategy called liquidity farming is connected with.
How does liquidity mining work?
As we already said, this is a method of obtaining passive income in cryptocurrency by blocking your assets within a certain pool of liquidity. Yes, in meaning it resembles the now classic staking, but there are differences. First of all, the presence of a stake share makes it possible to influence the development of the project and assigns certain responsibilities to the validator to maintain the system's performance. From those who give their assets to the liquidity pool, nothing is required in terms of supporting the project. But they also do not receive the right to manage the system. Not counting, of course, a few exceptions.
Further. Staking is always done within the blockchain. The liquidity pool can be outside of it, and work exclusively through smart contracts. They are the ones who keep the assets and pay the due remuneration.
As with staking, the reward is paid in a specific currency - usually in tokens directly related to the project. That is, for example, you invest some predictable and reliable stablecoin, and in return you receive an ERC-20 token, the price of which is determined only by the popularity of the project in which you are investing.
And, perhaps, the most important difference. At the moment, all pharming is inextricably linked to the Ethereum blockchain ecosystem. In the future, however, they plan to change this due to blockchain bridges, but so far the situation is clear. And staking can take place outside this ecosystem and not depend on the slow speed and high transaction costs that have already become typical for Ethereum.
Mining is also associated with projects based on the principle of automatic market making. Most often, these are various decentralized exchanges and exchangers. It is they who need a large amount of liquidity for normal functioning. And it is the providers of this liquidity that receive all or almost all of the transaction fees. However, the matter is not limited to only one commission. Very often, for making certain amounts, users are rewarded with internal project tokens, which cannot be purchased otherwise. And these tokens, in turn, can be used to replenish other liquidity pools. The chains can be quite long, but if done correctly, it will bring huge profits to the owner. Why? A simple example. You have deposited 1000 USDT into the pool. Now it brings you passive income, and in addition to it, you received 10 internal tokens. You contributed them to another pool and received another different internal token. So instead of the initial amount, 1000 + 10 tokens # 1 +1 token # 2 will work for you. Beneficial, isn't it?
Advantages and disadvantages
The advantages of liquidity mining are obvious - low entry threshold, affordability, ease of earning income. And for many, they clearly cover the shortcomings, which is not entirely true. Because there are many problems associated with pharming. So.
Intermittent loss. You deposit 100 DAI stablecoins and 100 # 1 tokens into a specific liquidity pool. That's right, since these are the conditions of most AMM exchangers. And you are counting on a certain reward over time. When the deadline comes (for example, part of the funds was leased and it is necessary to return it), it turns out that you, of course, received the commission, but the price of the internal token in which the reward was paid fell - once. And two - due to internal regulation mechanisms, you can only withdraw 50 stablecoins and 50 # 1 tokens. Here is the second situation - this is exactly the same "fickle loss". If you wait a bit, the situation should return to normal, but traders usually cannot wait.
Delay in payments. This is similar to what happens when staking. You will not be able to withdraw the deposited amount immediately. And she will not be able to immediately bring you income after investment. It will take some time (for each project - its own) to wait. And the time until the assets do not make a profit is losses and losses.
Problems with collateral. Only big whales are capable of immediately depositing a large amount in the necessary stablecoins. They are not afraid of either transaction costs or slippage, and there are no problems with the exchange. Smaller players have to borrow the crypto assets they need. And since DeFi is considered an unstable space by most lenders, you will have to deal with the so-called "loan security". Simply put, if you need 50 specific tokens to invest in a pool, then you have to pay for 100, get your hands on 50, and then return it in due time. And the higher the volatility of the market in which you are going to work, the more "collateral" will be.
Errors in smart contracts. Automation is not perfect. Smart contracts can contain errors since inception, and many projects do not have the resources to engage external auditors. Plus, keep in mind that we are talking about decentralized finance. If something goes wrong, and all transactions are irreversible, then no one will return anything to you. And this is perhaps the main risk, especially when you are dealing with new "promising" projects.
Compatibility issue. The main advantage of DeFi is the compatibility of various projects with each other, and it can turn into a disadvantage. Remember the situation described above - about 1000 stablecoins and the further chain of tokens from them? If the second pool (where 10 tokens are invested) turns out to be unreliable, then you will lose both everything invested in it and everything related to its internal tokens. And it's also good if this loss does not prevent you from withdrawing the original 1000 stablecoins (after all, lost tokens may indicate ownership of them). Therefore, if you have to work with several projects, it is better to make sure in advance that they are all reliable.
Complexity of the strategy. Experienced miners differ from beginners in that they are constantly looking for more efficient ways to invest their assets. Why? Situation. Beginner project. You deposit 1000 stablecoins into it, which will be 5 percent of the total liquidity pool. And it will entitle you to 5 percent of the entire commission. But if the project does not gain popularity, then it will be an insignificant amount. Plus, if the total liquidity pool drops, 5 percent of it will also decrease, and you will suffer losses. Therefore, experienced miners closely monitor the situation in the markets and are ready to withdraw their assets from projects that do not meet expectations at any time. Plus, here you can add the classic "diversification of the investment portfolio", and you have to follow several projects already. A separate problem is that no one seeks to disclose their investment strategies, since the less a person uses them, the more effective they are.
Examples of using
There are a number of projects that support liquidity pharming. The most famous among them are:
- Compound. Perhaps the main platform for farming. An automated system within the Ethereum ecosystem that allows crypto to be deposited into shared pools of liquidity, from which traders can borrow assets. Interest rates, in this case, are calculated automatically, as well as the commission.
- MakerDAO. Decentralized lending platform supporting USD-pegged DAI stablecoin. The user blocks his funds in ETH, BAT, USDC or WBTC, receiving DAI tokens as collateral. And certain interest on the deposit, the amount of which is regulated by the holders of the service's internal tokens - MKR. And the DAIs obtained in the process can be used for further farming.
- Uniswap. A decentralized exchange protocol that allows transactions in a non-custodial mode. Liquidity providers contribute certain amounts to two different tokens, creating a pool for their mutual exchange. In return, they receive a commission on these transactions.
- Curve Finance. Decentralized exchange protocol specializing in stablecoin swaps. Allows exchange with a minimum slippage value. Often used in farming due to its increased stability.
- Yearn.finance. Decentralized system of aggregators for credit services. Including those listed above. The goal is to automate the issuance of tokens by searching for the most profitable lending schemes. It is often used by those farmers who do not want to find the most effective applications on their own. Only the list of services from which information is collected is rather limited.
There is a reason why liquidity mining has become an object of close attention from investors. As long as interest in decentralized finance remains at a high level, pools will be in demand, and farmers, accordingly, will be provided with profits. Yes, everything is not as simple as it seems at first glance, but this is the situation in all sectors of the cryptocurrency space. Just getting started is difficult to achieve real success. In any case, the progress of DeFi could lead to a serious modernization of the very idea of blockchain and the technologies associated with it. And the fact that someone will definitely make money on this is inevitable.
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