“Liquidity farming has been in the limelight of the crypto space since 2020 and has been the backbone of the decentralized exchanges. The liquidity farming or also known as yield farming helps in providing the liquidity to the decentralized exchanges and helps in building their long term stability in the volatile crypto market. There is a lot of hype around Liquidity Farming and we must understand the risks associated with itt before investing out hard earned money.”
The Hype around Liquidity Mining
Since late 2020 the liquidity farming has been one of the most sorted concepts in the crypto space as it provides the power to a normal crypto investor to earn rewards like the mining in Bitcoin. To obtain rewards you only need to buy the cryptocurrency that you want to stake or lend into a farming pool. The rewards are obtained in the form of the cryptocurrency staked. As it acts like a bank account where an interest is obtained for depositing money and it is done through smart contracts in a decentralized manner.
The hype around liquidity farming is so high that billions of dollars have been locked in these farming pools to obtain rewards and in turn provide liquidity to the decentralized DEXs. To understand whether to buy the hype or not, we must understand the risks associated with it.
Liquidity Farming and the Associated Risks
It is one of the major risks associated with liquidity farming. As the crypto assets are locked, in the time period due to high volatility crypto asset price can go up and down resulting in two risks, one is of the opportunity cost and the other of the price loss.
Frauds and Rug Pulls
There are huge chances that the liquidity farming pools are created by fraudulent people who want to run away with all the investor’s money. 90% of cyber crimes account to these frauds and rug pulls. Thus, it must be extremely necessary to check the pools and DEXs before investing into them.
Smart Contract Risks
As these pools are run by smart contracts there is a risk that these smart contracts have bugs that can result in the loss of the crypto assets and also there is a chance of hacking into these smart contracts that can again result in losses to the investors.
During the locking period if the value of the crypto assets falls below the amount that will be reaped from rewards and the user requires the crypto assets to be sold, the loss in value will become permanent and the investor would have been better off keeping the assets on an exchange to trade.
The Crypto industry is an unregulated market and all the products in the cryptocurrency domain are unregulated at the moment. There is a chance that the Government or SEC bans a crypto lending platform or yield farming platform while the assets are locked. This can be a huge risk.
Disclaimer: The article is meant for the educational purpose only and in no way it should be considered as financial advice. Own research on the topic is advisable.
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