This article will give UX Designers an of the importance of liquidity in DeFi, and how early protocols like Compound have implemented liquidity mining programs to attract liquidity. This is part of an overall Web3 Design Bootcamp that teaches UX Designers about Web3 concepts and design patterns so they can land a job in the rapidly merging field.
Notice that suppliers on Compound are actually paid two interest rates. In the example above, where I’ve supplied ETH, one interest rate pays me back in ETH. This is from the interest paid by borrowers on their ETH loan. The other interest rate is paid in COMP. This is Compound’s liquidity mining reward, which is meant to incentivize me to keep my ETH liquidity locked in the protocol.
Back in 2020, Compound minted its COMP governance token with a fixed supply of 10M COMP. 4.2M COMP were allocated to its liquidity mining program, which distributes 1139 COMP tokens across its suppliers and borrowers on a daily basis. This will run for around four years until the allocated COMP runs out.
Compound was the first to implement liquidity mining, but many other DeFi protocols followed suit, using their own governance tokens as reward. These tokens give holders the ability to vote on governance proposals that could be anything from technical improvements to adjusting protocol parameters like interest rates and the list of assets approved for collateral (e.g. MakerDAO). Discussing protocol governance leads to the concept of Decentralized Autonomous Organizations (DAOs). This is an entire course module in itself that will be covered later. For now, understand that DeFi governance tokens have real-world value as they are traded on secondary markets, seen in the picture above.
Compound launched its liquidity mining program in June 2020. Other liquidity mining programs cascaded from there, leading to a boom known as “DeFi Summer”. Liquidity flooded into DeFi protocols as yields increased across the entire ecosystem. Look at the increase in Total Value Locked (TVL) in the chart above. The TVL chart shows all the token liquidity “locked” in all of the DeFi protocols on Ethereum. This could be tokens in DEX liquidity pools, Maker vaults, lending pools, and more. TVL is a great metric for comparing the health of DeFi protocols (e.g. AAVE versus Compound), as well as entire DeFi ecosystems (e.g. Ethereum DeFi versus Solana DeFi).
So far we’ve talked about several ways of earning yield on Web3 tokens, such as becoming a liquidity provider on a DEX, supplying tokens to lending pools, and participating in liquidity mining programs. In the next section we discuss another DeFi yield activity – staking – and show how DeFi users stack multiple yield activities on top of one another to maximize yield. This is known as yield farming.
If you enjoy videos over reading when it comes to online learning then checkout the course on YouTube. This is part 5 of 10 in the DeFi for UX Designers Course. Also, make sure to stay tuned for future Web3 Design Courses, which will cover emerging Web3 product categories.