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Author: Admin | 2025-04-28
Incentivized by the crypto protocols. It works in such a way: when crypto market participants have free funds and want to earn interest on them, they can deposit their crypto assets to the smart contract and get paid for it. It first started in 2020, when Synthetix – one of the pioneer DeFi protocols, established an incentive mechanism that became one of the key catalysts for the DeFi Summer.Later, we had Compound, which is a protocol that started to distribute COMP tokens to liquidity providers. This formula of paying users to transfer their stablecoins to Compound began a new era of DeFi when protocols competed with each other to offer the highest APY (annual percentage yield), thus achieving liquidity from DeFi farmers. However, this mechanism is not bullet-proof: 5. The Main Drawback of Yield Farming & Liquidity Mining The truth is, as long as you give the tokens as rewards, you will have liquidity providers with you. When the financial incentive (in the form of tokens) is gone, the liquidity providers are also gone. Such a phenomenon is called mercenary capital and stands for the money in the crypto space from investors focused on short-term profits. Why is that important?As you read before, liquidity is king. If the depth of the protocol’s liquidity is not stable (and even worse, dependent only on the financial incentive), we enter the dangerous ground. Because financial incentives cannot last constantly – they have to decrease in time (most often the incentives are planned only for the first months of operations to increase the interest in the protocol). Without changing the incentive program (and most often, lowering the liquidity mining APRs), the price of the token will quickly decrease because of the selling pressure from DeFi farmers – if the only incentive is to earn
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