Liquidity Mining: Potential Risks and what Paycer offers to avoid them
Liquidity is an essential condition for DeFi solutions to become successful. Without a possibility to convert different assets between each other, any young project is doomed because small startups rarely have sufficient budgets to instantly gain a vast number of users and thus maintain the circulation of their tokens on the needed level.
Liquidity pools represent a neat solution to this issue. Not only do they enable new projects to easily get an initial supply of liquidity, but they also serve as a secure and automated mechanism of passive income for end-users.
In this article, we are going to talk about liquidity mining, what associated risks investors may face, and how Paycer aims to eliminate them.
Liquidity pools explained
Let’s start with the basics. In its essence, a liquidity pool is a set of crypto funds locked in a smart contract. Initially introduced by Bancor, liquidity pools have gained much higher popularity with the release of Uniswap V2 in May 2020 thanks to the simplicity of use offered by the solution.
Here’s what the process looks like:
- To create a market, liquidity providers (LPs) lock a pair of 2 tokens with the same value in the pool.
- One of these tokens must be a coin with high liquidity such as ETH or MATIC. This helps LPs to ensure that the other token is backed up and can be traded off whenever it is needed.
- Whenever end-users of dApps want to buy or sell native tokens of these dApps, the transaction occurs in 2 steps with the liquid currency standing in the middle. Native tokens of applications are exchanged between each other without the involvement of any centralized exchange platform.
Thus, a blockchain startup issuing its own tokens and struggling to obtain liquidity may lock these tokens and ethers of the equal value in the pool and significantly facilitate the life of its followers. Thanks to blockchain, the whole process is secure, transparent, and fully automated.
Moreover, for providing their resources, LPs get rewarded. The passive income is generated from the native tokens of the platform and the trading fees charged for transactions happening in the pool. This is exactly what liquidity mining is about.
The potential risks of liquidity mining
Though this solution sounds like a dreamland, it still has its own pitfalls. Being aware of various risks inherent to the cryptocurrency industry, Paycer has its own ways to decrease or totally eliminate them when investing in DeFi platforms and liquidity pools.
#1. Price risk
The high volatility of digital assets may result in big losses when investing in liquidity pools as their prices may change dramatically in a short period of time. To avoid the associated risks, Paycer relies on the pools that have at least one stable coin such as DAI in the provided pairs.
#2. Impermanent loss
This kind of loss usually takes place when the ratio of the token pair significantly deviates in comparison to its initial state when the liquidity provider only locked these tokens in the pool. As the token price constantly changes, the loss may be reimbursed in the future if the token grows in value.
In addition to investing in the pools with stable coins, Paycer follows reliable investment strategies and thoroughly analyzes the coins to see if the projects standing behind them have the potential for future growth.
#3. Bugs in smart contracts
Another potential danger is associated with the smart contracts underlying the liquidity pools. The programming languages used in these contracts are typically more complex than those that developers have been working with in the past decades. Therefore, mistakes in the code exploited by hackers and resulting in the loss of funds are not a rarity here.
Wise projects with experienced teams rely on third-party auditors to check the code before launching it to the network. Paycer always checks whether the selected projects have applied to such services and only entrusts the funds to established protocols.
#4. Scam pools
Finally, there is always a risk of a project carrying out a scam pull. A scammer may create a pool with a scam token and a liquid currency such as ether. Then an infinite number of the scam tokens get minted to pull the liquidity for them from the pool. Alternatively, shady DeFi projects may simply perform an exit scam and get away with all the funds provided by investors.
The thorough analysis helps Paycer to avoid scam projects and invest only in those DeFi projects that have a viable product and respectable team members behind them.
Though DeFi represents an investment asset of high risk, there are ways to increase safety and still obtain good profits in this area. Paycer relies on these methods to offer its users a transparent and secure solution for investment. Want to become an early adopter or investor? Learn more about Paycer on:
