A common mantra in many financial systems is the idea that money can be used to make more money, and this is often the core principle at the heart of investing as a concept.
By either loaning money to be paid back with interest or buying equity in an asset expected to appreciate in value, money can accumulate over time, and investment can slowly grow larger and larger.
The reason for this is that liquidity is at the heart of investment and there must always be an incentive for people to buy in. Cryptocurrency is not only no exception to this, but it both requires and incentivises liquidity in order to make conversion in and out of the blockchain possible.
Much like how an engine seizes up without lubricant, the crypto market seizes up without liquidity, and investors can take advantage of this to make passive income.
There are a lot of different ways to do this, but two of the most popular ones are yield farming and liquidity mining, which are similar but slightly different concepts.
Here is how they work and how XRPaynet can help you get started making your cryptocurrency work for you.
What Is Yield Farming And Liquidity Mining?
In the context of decentralized finance, yield farming is a relatively general term for lending out crypto assets and receiving a return, typically in the form of either dividends or interest on the initial investment.
Exactly how this works can vary, but it can involve lending tokens directly or staking tokens in liquidity pools, which provide the digital capital required for many different projects to function properly.
A form of yield farming that is critical to a lot of modern DeFi is participating in staking pools to mine tokens such as is the case with Ethereum.
The Ethereum proof-of-stake consensus mechanism is a system where participants stake capital (in this case in the form of 32 ETH), and are then entered into a weighted process where the winning participants validate a block of transactions and are rewarded with Ether in the process.
This is, at a basic level, how yield farming works; assets are locked up in a protocol via a smart contract, and rewards are earned based on certain conditions of participation.
A variation of this, known as liquidity mining, is where tokens are placed into a liquidity pool in the same way money is placed into an investment fund. The money is used to provide liquidity and capital to enable a given system to work, and the liquidity provider (LP) is rewarded with a
share of the fees, newly generated tokens or both.
The most common forms of liquidity mining are found within decentralized exchanges (DEX) which function based on a system of automated market makers (AMM).
The AMM controls the price of trading particular token assets based on supply and demand, and rewards are generated based on the percentage of ownership of a liquidity pool a person has through their level of investment.
Other forms of yield farming involve effectively acting as an angel investor, getting in on the ground floor of projects with ownership based on a governance token that can itself be sold similarly to the share of a company.
Whilst conceptually yield farming and liquidity mining are similar to lending and especially staking, you have the freedom to take your tokens out of the pool after a lockup period to ensure that capital does not immediately vanish. This means that they can be very lucrative, but also very volatile.
There is also the potential for an impermanent loss, where the value of an asset changes in either direction relative to the liquidity pool, although this changes depending on the volatility of the assets in question.
How Can You Get Involved With Yield Farming?
The easiest way to get started with yield farming is to sign up for an XRPaynet wallet using our mobile application or by signing up for a crypto card, and invest using the XRP Ledger in one of over 300 potential cryptocurrencies.
Choose a currency pair liquidity pool that suits you and has a strong annual percentage yield (APY) and invest in it. In practice, this means that you will stake both sides of the pool equally and earn transaction fees and any rewards generated by being part of a particular DEX, AMM or liquidity pool.
As with any investment, make sure you do thorough research into any liquidity pool you invest in, find out what you are expected to receive and do not invest more than you are able to lose.