Liquidity mining just got easier with shared liquidity mining pools.

Liquidity mining means that you provide liquidity to a decentralised exchange and receive block rewards and a share of the transaction costs directly from the blockchain in return.

Decentralized Exchanges vs. Centralized ExchangesThe processes on a decentralised exchange (DEX) are different from those on a classic centralised exchange.

One of the most important differences between these two types of exchanges is that decentralised exchanges do not have middlemen who can bring buyers and sellers together and slow down and increase the cost of transactions.

Thus, decentralised exchanges need a different solution. A solution that allows transactions to take place peer-to-peer, i.e. purely between two people.

Order book replaced by liquidity pool

In order to be able to carry out swaps on a DEX, the classic order book used on centralised exchanges must be replaced by a so-called liquidity pool. This liquidity pool is what makes the exchange (the "swap") from one coin to another coin possible in the first place (for example, from BTC to DFI).

A liquidity pool is nothing more than a pooling together of a specific coin pair (for example, DFI and BTC in a liquidity pool). Liquidity can now be added to this pool in the form of two coins, which are added to the liquidity pool in equal shares (50:50) based on the current prices on DEX.

How are the rewards generated?

For adding coins to the liquidity pool (and thus providing liquidity) - also called liquidity mining - rewards (block rewards) are distributed directly from the blockchain in return. In addition, the transaction costs incurred are distributed proportionately to all participants in a liquidity pool.

These rewards (distributed in DFI) and proportional transaction costs (distributed in the other coin of the respective liquidity pool, e.g. BTC, ETH, etc.) make the provision of liquidity attractive, as this is often accompanied by high returns (see current liquidity pool APY).

Liquidity Mining risks

Nevertheless, one should also be aware of any risks that may be associated with liquidity mining.

Many blockchains are based on a Turing-complete blockchain, which requires a lot of code. The more code that is written, the more opportunities there are for programming errors.

However, DeFiChain - the blockchain used by Cake DeFi for liquidity mining - is non-Turing complete and needs up to 99% less code compared to Turing complete blockchains. Therefore, Liquidity Pools on DeFiChain are less vulnerable to programming errors and hacks.

Another risk that must not be neglected when Liquidity Mining is Impermanent Loss.

A so-called impermanent loss always takes place when the ratio between the coin pairs of a liquidity pool changes. If the coin pairs have moved in opposite directions since the liquidity was provided - one coin has outperformed the other in value - and you then decide to withdraw the liquidity again, you will receive less from one coin than you originally put in. This is called an impermanent loss. However, this does not apply to the other coin, because you now get out more of it.

This is due to the swaps that cause the price fluctuations: When swapping from BTC to DFI, for example, Bitcoin is added to the liquidity pool, but DFI is taken out. In this example, you as a liquidity miner have gained BTC but lost DFI.

In general, however, the impermanent loss is low and does not usually exceed the amount of rewards received, unless there are particularly strong price fluctuations within a coin pair.

To keep the impermanent loss as low as possible for our Cake DeFi customers, we use a display tool that shows you exactly when you are exposed to an increased impermanent loss risk and when you are not (DEX market price stability).