With more and more cryptocurrency platforms offering attractive returns in excess of 1,000%, the old and very irritating phrase that is sure to come out of the mouths of regulators, financial institutions, ordinary investors and now billionaires is that if it looks too good to be true, it probably is.
We are referring to the world of liquidity mining and pledging.
Let’s explain what these terms mean and look at the meaning behind them to assess whether liquidity mining and/or pledging should be a legitimate investment for investors to focus on.
Pledging is a mechanism derived from the proof-of-stake consensus model and is an alternative to the energy-driven 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 technicalities of building nodes. The problematic exchanges will handle the verification part of the process themselves, while the pledgor’s only job is to provide the assets.
The main purpose is not to provide liquidity to the platform, but to secure the blockchain network by improving its security. The more users pledge, the more decentralized the blockchain becomes, and therefore the harder it is to attack.
While pledging is often associated with proof-of-interest networks, it has taken on a life of its own. Many crypto projects have used pledging as a way to create “stickiness” on their platforms. By offering users a way to earn income by holding tokens, it prevents them from moving their money to another platform, and that’s the theory anyway. Of course, the high returns have another effect. They encourage investors to buy tokens, leading to scarcity and driving up prices.
Pledged returns are provided in the form of interest paid to the holder by the token. Rates vary by network and platform, depending on several factors including supply and demand.
Cryptocurrency pledges have recently become increasingly popular due to the attractive returns investors receive. Currently, rates offered through pledges range from 6% per year offered by well-known networks such as Ether (ETH) and Caldano (ADA) to over 100% offered by platforms such as PancakeSwap (CAKE).
Risks of pledging
Pledging returns on cryptocurrencies is not without risk, as several factors may affect the performance and security of the tokens pledged.
The first risk is the possibility of a cybersecurity event that could result in the loss of the token held. This recently happened with the Pancake Bunny project, a once highly successful project that saw its price plummet by more than 90% after a massive attack.
Another risk of pledging comes from the potential drop in crypto asset prices during the pledge period. Because pledges are made by locking in tokens, investors will not be able to liquidate their holdings in the event of a market decline, exposing them to the risk of losing a portion of their principal without being able to mitigate their losses by selling.
On April 29th, we listed Polywhale, the first and largest decentralized liquidity mine on Matic, as a project to watch closely. It has accumulated a total value lock of $75 million and has quickly escalated to over $300 million in just a few weeks. This is driven by an APR of over 1000%. With a market value of $35 million and a token price of $133, this project looks like a good deal. Within a few days of us giving the tip, this price went up to $237. But then the price started to decline. In less than two days, the price dropped to $62 and is now a miserable $0.17. Of course, as the price drops, so does the TVL. Now the figure is a paltry $2 million.
In Polywhale’s case, this means that chasing a high APR is risky. The higher the APR, the higher the risk. what Polywhale shows is that when asset prices start to fall, high returns create some degree of stickiness, and investors become loyal.
Liquidity mining is the practice of pledging or lending out cryptocurrency assets to generate high returns or rewards in the form of additional cryptocurrencies. This application of decentralized finance has recently become hugely popular due to various innovations. Liquidity mining is currently the biggest growth driver in the DeFi industry.
In short, liquidity mining incentivizes liquidity providers (LPs) to hold or lock in their crypto assets in a smart contract-based liquidity pool. These incentives can be a percentage of transaction fees, interest from lenders, or governance tokens. As more investors inject money into the associated liquidity pool, the value of the issued returns rises.
Liquidity mining occurs when liquidity mining participants are rewarded with tokens as additional compensation, and became prominent after Compound released its COMP governance tokens to its platform users.
Most liquidity mining protocols now reward liquidity providers with governance tokens that can typically be traded on centralized exchanges like Coinan and decentralized exchanges like Uniswap.
By introducing governance tokens and moving away from proof of equity, there is some crossover between equity investments and liquidity mining.
Risks of liquidity mining
Liquidity mining usually requires paying higher ethereum gas fees, but with the popularity of the CoinA smartchain and its lower gas fees, the opportunities for investors have increased.
Users are also exposed to greater risk of unpredictable losses and price declines when the market is volatile.
Liquidity mining is vulnerable to hacking and fraud due to the potential vulnerability of the protocol’s smart contracts. These coding errors can 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.
There has been an increase in high-risk protocols that issue modal tokens capable of delivering thousands of APY returns. Many of these liquidity pools are scams where the project owner removes all the liquidity from the pool and disappears with the funds.
Tedd.Finance is one of the newest modal tokens offering over 100,000% APY, which is apparently achieved by investing in a mine-based pool. In their short history, they have managed to accumulate over $500,000 in TVL. the highest return on their site is 17,200%. Of course, this is a new project and investors are pledging that they will be able to liquidate their tokens quickly if the need arises. But that doesn’t seem too easy.
Temporary losses occur when an investor provides liquidity to a liquidity pool and the price of the deposited asset changes from the time it was deposited. The greater the change, the greater the impermanent loss.
Pools that contain assets (such as stablecoins) with relatively small price ranges have less impermanent losses.
The impermanent loss can still be offset by transaction fees. For example, pools exposed to impermanent losses on Uniswap can be profitable due to transaction fees.
Uniswap charges a 0.3% fee for each transaction that flows directly to the liquidity provider. If a particular pool has a high volume of trades, providing liquidity can be profitable even if the pool is exposed to severe anomaly losses.
The YAM protocol is a DeFi protocol launched in August 2020. YAM tokens were supposed to maintain parity with the US dollar and be used for on-chain governance.
The YAM team stated that they created the YAM protocol in just 10 days. The team also warned that no formal audit of the YAM protocol had been conducted. Within an hour of launch, the YAM protocol received $76 million in investment. within 24 hours, nearly $300 million. the YAM token touched an all-time high of $167.72.
Shortly after YAM hit an all-time high, the YAM team discovered a major vulnerability in the protocol. They announced that a vote would allow the community to execute a bug fix if they locked in 160,000 YAM in the governance proposal smart contract.
However, after making the 160,000 YAM required to execute the proposal, the team admitted that they found the smart contract to fix the vulnerability to be flawed and that there was no way to resolve the issue.
The YAM team announced that the project was dead. YAM has a lifespan of no more than 48 hours. YAM tokens fell to $0.81, down 99.4% from its all-time high.
Current Pledge and Liquidity Mining APR Table
Risk indicates that risk is relative. The risk assessment on this table is based on the relative risk of holding cryptocurrencies as an investment. As an investment, cryptocurrencies are risky. For example, the risk of pledging through Coinbase is low compared to investing in newly minted modulo coins, but still high compared to other investment categories.
Another important point to note is that while a platform may be rated as low-risk, investors must remember that the higher the reward offered, the higher the risk. In other words, a low-risk platform can offer a high-risk investment.
Pledging and liquidity mining used to be two completely different worlds. However, in recent times, there has been a tendency to merge the definitions of the two. While liquidity mining focuses on getting the highest possible return with the goal of creating liquidity, the purpose of pledging has expanded from helping blockchain networks stay secure to pledging tokens on a given platform to earn a return.
There is a place for liquidity mining and pledging in cryptocurrencies, but investors must be aware of the risks and avoid the lure of high APRs. platforms such as PanckaeSwap justify their lucrative returns by the share of fees they take in their pools. Other programs that offer large APRs are not so lucky. They don’t have the large community that PancakeSwap benefits from, the depth of the product, or the huge volume of transactions that would allow them to generate a lucrative revenue stream.
Many new projects are one-trick ponies with high APRs as their only trick. The price of these tokens is inevitably tied to their TVL, which raises the price of the token and allows them to continue to offer generous prices. But once the price softens, it starts to fall, and it can fall quickly, as seen in the two case studies above.
Before investing through any pledging or liquidity mining platform, it is important to evaluate the trading volume and liquidity of the pledged tokens. Liquidity is necessary. It is also important to consider whether the project has more depth than a simple pledge platform. Many modem type projects have emerged recently that offer coveted returns but no fundamentals.
Posted by:CoinYuppie，Reprinted with attribution to:https://coinyuppie.com/liquidity-mining-and-pledging-a-trend-of-merging-the-two-concepts/
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