We have talked about yield farming in the previous article. In today’s article, we will talk about liquidity mining. It seems similar to yield farming but actually, it is not. So, if you are curious enough to know more about liquidity mining and whether or not it is permissible in Islam, then this article is for you.
What is Liquidity Mining?
Firstly, let’s get to know its basic concept. Liquidity mining is an activity where you can mine tokens because you put your bitcoin in the liquidity pools. Then, what is a liquidity pool? A liquidity pool is a place to put a lot of tokens (cryptocurrencies). You might be wondering why this activity exists, so let’s move to the next part.
Why this scheme exists?
As you might know that liquidity means the easiness to convert an asset to cash. For instance, an office building is an illiquid asset. Since office building usually takes a long time to decide to sell and find a good deal. On the other hand, stocks are liquid assets because it is easy to convert them into cash.
Now, imagine you have bitcoin and you need some ethereum but no one has ethereum that you need, so you can not exchange it. In another place, there is someone who has ethereum and needs bitcoin but he does not know you. Therefore, a liquidity pool exists for people who need to exchange their cryptocurrencies.
To fill the liquidity pool, there are liquidity providers. A liquidity provider is people who put their tokens (cryptocurrencies) into a liquidity pool so that the exchange between cryptocurrencies can be more liquid. Now, imagine if the liquidity pool only consists of two counterparties who need to exchange, there will be a possibility that one of them is lack of bitcoin or ethereum. For example, Ali has 1 bitcoin that equals 30 ethereum. Hamza has only 20 ethereum and wants to exchange his ethereum with bitcoin. It is not balance, right?
Liquidity pool makes it easier to exchange
So, to make it easier for Ali and Hamza, there is a liquidity pool that is filled with tokens from liquidity providers. The more tokens inside, the transaction would be more liquid. Thus, to appreciate the liquidity providers who put their tokens, they will receive more tokens.
The activity of receiving more tokens as an appreciation because we put our asset is called liquidity mining.
Is it halal?
Firstly, liquidity mining is exactly putting your money at risk because you can not take it back once you put it into liquidity pools. You put your money into an activity that contains risk and there is a possibility to gain both profit and loss, just like investing in stocks.
Secondly, it is not a loan since there is no borrower. People like Ali and Hamza in the previous story are only using cryptocurrencies provided by liquidity providers to exchange, not borrowing. It is different from yield farming where your money is lent and you get riba (interest) from it.
In conclusion, the concept of liquidity mining does not violate the Shariah principles, and it is permissible. In liquidity mining, users put their own money on the platform in exchange for a percentage of the fees. This fee is basically similar to Ujrah (fee) concept, whereby the participants are incentivized based on their effort to supply cryptocurrencies into liquidity pools. The Liquidity providers are rewarded with extra tokens in exchange for risking their money to increase liquidity.
To read more about Islamic Finance related topics, please click here and visit our academy.
Besides, feel free to sign up for our free stock screening services at musaffa.com.
Pingback: What You Need to Know About Yield Farming - Musaffa Academy