▶️What's Liquidity Mining?
Under the AMM mode, algorithmic robots simulate trading behaviour to provide liquidity for the market. Every market that supports AMM has a corresponding funds pool in which market-making funds will be provided for AMM. The quotation of the AMM is determined by the ratio of the two coins in the pool, and the product of the two coins' amount will remain the same when trading. This model is also called Constant Product Market Maker.
Users can become Liquidity Providers (LP) by providing liquidity to the pool, indirectly becoming a market maker and earning commission dividends from trading fees, which is known as liquidity mining.
▶️How do users get liquidity mining yields?
Users will receive reward tokens (liquidity tokens) for depositing assets into the pool. The pool generates fees whenever there are transactions, and the tokens are distributed according to the established reward rules, which are the liquidity mining yields.
The calculation of liquidity mining yields follows the metrics commonly used in traditional markets: annualized percentage rate (APR) and annualized return ratio (APY). The main difference between the two is that APR uses Simple Interest in the calculation and only focuses on the ratio of interest to invested principal; APY uses Compound Interest in the calculation. In addition to interest and principal, it must also take into account the effect of different periods of interest on increasing the principal. Due to the fierce competition in the liquidity mining market and the rapid flow of funds, the income fluctuates greatly, the APR and APY only reflect the current valuation which can be used as a reference. The long-term income performance is subject to the actual investment.
The liquidity mining market is highly competitive, and yields are highly volatile. No matter which calculation method is used, the results shown are only a valuation and are for reference only.
The Annualized Percentage Rate (APR) is a measure of interest earned and the conventional formula is APR = the sum of interest and fees / principal amount borrowed; while the Annualized Percentage Yield (APY) represents the annual percentage yield and will take into account the compound interest. The compound interest is the additional interest earned from the principal and the interest earned on the principal.
▶️Advantages of Gate.io Liquidity Mining Projects
Gate.io has always taken security as the core of its services. It is ranked second in security by a third-party security testing laboratory that has tested the security of 100 crypto coin exchanges around the world. Relying on a highly-secure platform for liquidity mining investments, investors can effectively avoid project risks and earn returns at a more robust rate.
Similar to UNISWAP V2, Gate.io has introduced an automated market maker approach to liquidity mining. However, Gate.io has a much higher trading volume, which means that the Gate.io platform is able to provide more transaction fee revenue to allocate to liquidity providers.
Richer Asset Portfolios
Gate.io not only serves as a cryptocurrency trading platform but also offers a wide range of cryptocurrency-related financial services and financial products. Taking advantage of the feature that users of liquidity mining can withdraw and deposit their assets at any time, investors can exploit the services and products offered by Gate.io to dynamically adjust their portfolios and investment solutions. As a result, they don't have to trade across different platforms, saving their time and costs. For example, when the market becomes increasingly volatile and impermanent losses rise, investors can withdraw the currency deposited into the liquidity mining pool at any time and achieve volatility arbitrage. On the contrary, when the market moves smoothly and currency prices are stable, investors can inject their own currency holdings into the liquidity mining pool and earn extra returns.
Considerate and Thoughtful Guidelines
Liquidity mining on a decentralised project requires a lot of preparation from investors, which is cumbersome and requires investors to calculate their own expected returns. However, Gate.io offers investors an easy way to invest in liquidity mining products. Once users follow the guidelines, they can pledge and unlock currencies for liquidity mining. Gate.io has also designed an impermanent loss daily return ratio to quantify the impermanent loss compensation cycle. Please go to the Gate.io announcement, “Gate.io Launches BTC, ETH, UNI, SHIB, DOGE, GT, FIL, LTC, XRP, DOT and ETH-BTC Liquidity Mining,” for details.
▶️Risks of liquidity mining
The liquidity providers put assets into the liquidity pool of two different tokens. Violent price fluctuations will result in significant skew in the proportion of tokens in the liquidity pool, causing the number of one of the tokens to surge and the other to plummet. Since both the addition and redemption of liquidity are done on a ratio of 1:1, it is possible for the liquidity provider to encounter the fact that the amount of currency invested and the amount of currency withdrawn are different. Such a change in the number of coins and net asset value caused by fluctuations in market prices is called impermanent loss. It can also be regarded as the opportunity cost of participating in liquidity mining.
Whether the price of tokens rises or falls, impermanent losses will occur. The greater the price deviation, the greater the impermanent losses. Even if the price doubles, the impermanent loss is only 7%. However, an impermanent loss of 7% is rather low compared to the income earned in liquidity mining. Moreover, when the market price falls, an impermanent loss will also disappear.
As an application deployed in the blockchain, smart contracts are the framework for building decentralized finance. It is customizable, transparent, non-tamperable and autonomously operated. All these features make it unnecessary for users in traditional finance to return to a third party for help, which has significantly reduced operating costs.
Liquidity Pools & Liquidity Providers
Liquidity mining allows users to stake the cryptocurrencies they hold in a liquidity pool on a decentralized exchange based on blockchain. These users who provide cryptocurrency assets into the pool are called Liquidity Providers. Meanwhile, they will get transaction fees and protocol rewards.
Automated Market Maker (AMM)
Decentralized exchanges generally use the Automated Market Maker (AMM) protocol, an algorithm or a formula that helps in pricing assets. In traditional finance, the quotation of commodities is created using an order book. The buyer and the seller each put forward the price and wait for the order to be matched. The market price is the latest price. Under the automated market maker mode, users don’t need to match counterparties to make a trade happen. Instead, they can directly buy or sell cryptocurrencies from the liquidity pool. The price is determined by the algorithm. The Constant Product Market Maker is the most common algorithm. The formula is x * y = k. Both "x" and "y" represent the number of two currencies respectively in the liquidity pool, and the value of “x” timing “y” is fixed.
Order Book Trading vs. Liquidity Pool Trading
There are a few major differences between order book trading and liquidity pool trading. First of all, the liquidity in order book trading is provided by pending orders from buyers and sellers, while the liquidity of the liquidity pool trading is provided by users who pledge cryptocurrencies in the protocol. In addition, the quotations in order book trading are non-continuous, and there will be a price difference between the buy order and the sell order. However, liquidity pool trading uses mathematical formulas. As long as there are crypto assets in the liquidity pool, continuous quotations will be generated, so that the users will not encounter the case that a trade cannot be done because the order fails to find a match. Finally, transaction fees for order book trading are usually charged by centralized exchanges that operate the markets, while in the liquidity pool trading transaction fees are distributed to liquidity providers.
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