What is yielding (liquidity)?
Similar to depositing money in a bank, you can block your cryptocurrency, called “staking,” for a certain amount of time in exchange for interest or other consideration, such as cryptocurrency. benefit.
Since the start of liquidity provision in 2020, liquidity providers have made a profit in the form of an annual percentage return (APY) that can reach triple digits. However, this potential return is at high risk if protocols and rates are subject to extreme volatility and conflicts with developers who abandon the project and investors’ funds.
Note: Liquidity gain is expressed as the APY or rate of return that you will earn during the year.
How does liquidity provision work?
Liquidity extraction works by first allowing an investor to place a bet by depositing their coins in a loan protocol using a decentralized application or dApp. Other investors can then borrow coins using dApp to use them for speculation in an attempt to profit from sharp fluctuations in the cryptocurrency market price.
Block-based applications offer incentives to users to provide liquidity by locking their coins in a process called stacking. Rates occur when centralized cryptocurrency platforms take deposits from customers and lend them to loan seekers. Creditors pay interest, depositors receive a certain portion of it, and then the bank receives the rest.
This lending is facilitated by smart contracts, the part of the code that normally operates in a blockchain and acts as a liquidity fund. Users who obtain liquidity, also known as liquidity providers, lend their funds by attaching them to a smart contract.
Investors who lock their coins in a profit-making protocol can earn interest and generally more cryptocurrency. If the price of these additional coins increases, so will the investor’s profits.
This process provides the liquidity required for startup blocking applications to ensure long-term growth. These apps can increase community engagement and provide this liquidity by rewarding users with incentives such as management tokens, app transaction fees, and more.
Note: A hard prong is a cryptocurrency network protocol change that causes a block or transaction to validate or invalidate, forcing developers to upgrade their protocol software.
Forced bifurcation allows cryptocurrency holders to drive changes that will move the cryptocurrency forward, at least in the opinion of most holders. In a way, hard forking gives cryptocurrency investors a similar power as stock votes to shareholders. Just as shareholders can vote on key issues that affect the management or direction of the companies in which they invest, cryptocurrency owners can use a “hard fork” to steer the cryptocurrency protocol in a particular direction.
Is it safe to obtain liquidity?
Gaining liquidity is full of risks. Some of these risks are:
Volatility: Volatility is the degree to which the price of an investment fluctuates. A volatile investment is one that undergoes significant price changes over a short period of time. If the coins are locked, the price of your coins may increase or decrease.
Fraud: Liquidity miners may inadvertently insert their coins into fraudulent projects or schemes that result in all miners’ coins being obtained. Fraud and abuse account for the largest share of $ 1.9 billion in cryptocurrency crime in 2020.
Carpet Pulling: Carpet pulling is a form of exit fraud in which a cryptocurrency developer raises investor funds for a project and then leaves the project without returning the investor’s funds. Almost 99% of large-scale fraud in the second half of 2020 was caused by carpeting and other scams that are particularly vulnerable to miners.
Smart contract risk: Smart contracts used to obtain liquidity may be flawed or vulnerable to attack, thus compromising your cryptocurrency. Most of the risks associated with efficient extraction are related to the underlying smart contracts. Better code reviews and third-party audits increase the security of these contracts.
Permanent Loss: The value of your cryptocurrency may increase or decrease as you place bets, resulting in temporary unrealized gains or losses. These gains or losses become permanent when you withdraw your coins, and if the losses outweigh the interest earned, it may put you in a better position to keep the coins ready for sale.
Regulatory risk: There are still many regulatory issues related to cryptocurrency. The SEC (Securities and Exchange Commission) has stated that some digital assets are securities and therefore allows it to regulate them within its jurisdiction. Government regulators have already issued suspension and termination orders for one of the largest cryptocurrency lending sites, BlockFi.
Is it profitable to obtain cryptocurrency liquidity?
While obtaining liquidity is undoubtedly risky, it can also be profitable. Otherwise, no one would try. CoinMarketCap provides Yield Classification with annual and daily APYs of various liquidity funds. It is easy to find pools that operate with double-digit APY per year and in some cases with one thousand percent APY.
However, many of them also have a high risk of permanent losses, leading investors to question whether the potential consideration is worth the risk. As with investments in cryptocurrencies in general, the profitability of liquidity provision remains highly uncertain and speculative. The potential return is pale in comparison to the risk of locking coins during liquidity.
Your total profit will also depend on how many cryptocurrencies you can deposit. Making a profit requires thousands of dollars in funds and extremely complex strategies. . Here are five liquidity protocols you need to know:
Aave is an open source liquidity protocol that allows users to lend and borrow cryptocurrencies. Depositors earn interest on deposits in the form of AAVE tokens. Interest is earned based on market demand for borrowing. By using the deposited coins as collateral, you can act as both a depositor and a borrower.
Compound is an open source protocol for developers that uses an algorithmic, autonomous interest rate protocol to determine the rate that depositors earn from the coins they charge. Depositors also earn COMP tokens.
Curve Finance is Ethereum’s liquidity pool that uses a market maker algorithm to allow users to exchange stable coins. Pools using stable coins may be safer because their values are pegged to another medium.
Uniswap is a decentralized exchange in which liquidity providers must divide the two sides of the pool 50/50. In return, you earn a portion of the transaction fees as well as the UNI management token.
Instadapp is designed for developers and allows users to create and manage decentralized financial portfolios. More than $ 12 billion has been blocked in Instadapp since October 31st.
Liquidity collection involves the blocking of cryptocurrencies or multiple interest rates in your currency. As cryptocurrency becomes more popular, liquidity gathering will become more common. It is a simple concept that has existed since the existence of banks and is only a digital version of lending to investors for profit.
Although obtaining liquidity provides a high return, it is incredibly risky. A lot can happen while your cryptocurrency is locked, as evidenced by the many sharp price fluctuations that are known to occur in cryptocurrency markets.
Before embarking on liquidity provision, it is best to understand how liquidity provisioning works and all the risks and opportunities involved.
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