🟢Rewards
There are three mechanisms of earning coins or tokens as a reward:
I. Yield Farming
Yield farming is perhaps one of the most innovative features of Decentralized Finance (DeFi). It refers to the activity of allocating capital to DeFi protocols to earn returns.
Most DeFi protocols are peer-to-peer financial applications where capital allocated is used to provide services to end-users. The fees charged to users are then shared between the capital providers and the protocol.
There are two terms that we need to know before understanding more about yield farming:
Liquidity Pools: Liquidity pools are token reserves that sit on smart contracts and are available for users to exchange tokens. Currently the pools are mainly used for swapping, borrowing, lending, and insurance.
Liquidity Mining: The reward program of giving out the protocol's native tokens in exchange for capital. It is a novel way to attract the right kind of community participation for DeFi protocols.
Along with two terms above, yield farming can be divided into two operations. However, there could be other methods of yield farming beyond the two below:
Lending Platforms
DeFi lending platforms such as Compound, Aave and Maker have similar underpinning principles. At their core, they are lending protocols. To understand how they work, let us look at Compound Finance. Compound Finance is a DeFi lending protocol. In more technical terms, it's an algorithmic money market protocol. You could think of it as an open marketplace for money. It lets users deposit cryptocurrencies and earn interest, or borrow other crypto-assets against them. It uses smart contracts that automate the storage and management of the capital being added to the platform.
The assets held in the liquidity pool are lent on interest and the pool earns income through borrowing. The returns that are generated are through lending contracts. The balance of crypto is lent to others. At any time, a liquidity provider can redeem their cUSDC for normal USDC plus interest paid in USDC.
Sharia Perspectives:
Since the yield in yield farming on lending platforms is created through lending contracts, the yield is usury (riba). In Islam, a loan (Qard) is a gratuitous contract and lending to people in need is a commendable practice. Both the Qur’an and Sunnah promise reward to a lender who provides a loan to a person in need. Qard agreement is a form of social assistance to keep the community together through hard times. Thus, any profit or additional return in lieu of the loan is impermissible and non-sharia compliant. Interest is explicitly prohibited in the Qur’an and the Sunnah. And Allah Knows Best
2. Decentralized Exchanges
A DEX is a platform that enables trading and direct swapping of tokens without the need for an intermediary. Most of the DEXs are liquidity pool based.
Liquidity pools, in terms of DEX operations, are token reserves that sit on DEX’s smart contracts and are available for users to exchange tokens with. Most liquidity pool-based DEXs make use of Automated Market Makers (AMM), a mathematical function that predefines asset prices algorithmically.
AMM is one of the most innovative inventions from DeFi in recent years. It enables 24/7 market hours, higher capital accessibility, and efficiency. There are various types of AMMs, and different DEXs have implemented the various "flavors". The majority of DEXs that launched during the DeFi summer 2020 are AMM-based DEXs such as Uniswap, SushiSwap, Curve, Balancer, and Bancor.
You can think of liquidity pools as just pools of tokens that you can trade against. Above picture shows that if you wish to swap ETH to DAI, you will trade on the ETH/DAI liquidity pool by adding ETH and removing an amount of DAI determined algorithmically from the liquidity pool.
Depositors, known as Liquidity Providers (LPs), seed these liquidity pools. LPs deposit their tokens into the liquidity pool based on the predefined token weights for each AMM. Whenever liquidity is deposited into a pool, unique tokens known as liquidity pool tokens (LP Tokens) are minted and sent to the provider's address. These tokens represent a given liquidity provider's contribution to a pool.
LPs provide funds in liquidity pools because they can earn a yield on their funds, collected from trading fees charged to users trading on the DEX. The fees which are accumulated during every swap through the DEX, based on the proportion you have contributed to the LP. e.g., if you contributed 10% of the total LP, you shall receive 10% of the total fees. These fees are automatically contributed to the LP, so your total personal LP contribution keeps on increasing according to accumulated fees. For example, in TraderJoe, a DEX on Avalanche Blockchain, you earn 0.25% of all trades on particular pair proportional to your share of the pool. Fees are added to the pool, accrue in real-time, and can be claimed when you withdraw your Liquidity.
And not just share a portion of trading fees, typically DEXs have incentive program to attract & retain LPs participation by giving out the protocol's native tokens in some particular liquidity pair. This can be done by staking LP tokens, and this is in DEX documents usually referred to yield farming itself or in some references called liquidity mining or liquidity farming.
The following is a flowchart of how to do yield farming in general. For more details, refer to the respective DEX documents.
Impermanent Loss
Yield farming, particularly in providing exchange liquidity, is not without risk. Impermanent Loss (aka IL) is one of the risks you take on for being a liquidity provider and is a result of how AMMs function. Large swings in the relative price difference of the two tokens in the pool could result in a loss compared to holding the tokens themselves if you withdraw at that precise moment (hence the term impermanent). The loss is only "permanent" if you withdraw your liquidity completely, however that does not mean the IL will necessarily go away over time. Generally speaking, the trading fees received for being a liquidity provider and the yield from the farm can offset IL risk, but nothing is guaranteed.
Perspektif Syariah :
According to Shariyah Review Bureau about trading fees, since the traders are coming onto a platform and are being provided the space and platform to trade tokens, this permits a fee for the transaction to use the DEX. And since the decentralized exchange is primarily dependent on the LP providers, the LP providers are central to the infrastructure and operations of the DEX. Therefore, transaction fees are permissible to earn for LP providers.
In the same paper, they conclude that if tokens are provided to a lending platform, then such an activity is not Sharia compliant since interest-lending is involved. Yield farming that involves DEXs has the potential to be Sharia compliant depending on the underlying mechanisms of liquidity mining and the nature of the income.
In our opinion, trading fees from providing exchange liquidity are permissible. What needs to be considered is that each crypto asset that will be paired to be LP Tokens must comply with halal crypto principles based on its substances. For example, if you provide liquidity for the AAVE-USDC pair, then obviously the rewards you earn from it are impermissible.
Incentives in the form of native tokens of a DEX are permissible as well. This is protocol's way of attracting and retaining liquidity providers. And with this, the risk of impermanent loss may be covered. And Allah knows best.
Reading References :
How to DeFi : Beginner, by coingecko research team, 2nd edition 2021
How to DeFi : Advance, by coingecko research team, 1st edition 2021
II. Mining & Staking
There are currently two main ways of adding a transaction block to a blockchain.
1) Proof of Work (PoW)
2) Proof of Stake (PoS)
If you know how Bitcoin works, you’re probably familiar with Proof of Work (PoW). It’s the mechanism that allows transactions to be gathered into blocks. Then, these blocks are linked together to create the blockchain. More specifically, miners compete to solve a complex mathematical puzzle, and whoever solves it first gets the right to add the next block to the blockchain then rewarded with bitcoin.
While in a proof of stake (PoS) system, users who own some of the cryptocurrency ‘lock’ or hold their funds in a wallet. Instead of having to solve maths puzzles to add blocks to the chain, users are selected at random based on how much currency they have locked up. The user who is chosen at random is rewarded with a coin. Typically, how it works is the more coins you hold the more you can ‘earn’, so the size of your stake is directly proportional to the chances of being chosen to forge the next block and earning coins. This is called staking.
Thus, mining and staking activities serve the same purpose, which is adding blocks or validating transactions on the blockchain. However, staking in term of validating transaction on the blockchain, must not be confused with staking in terms of DeFi space, such as yield faming (please refer to Yield Farming section).
Sharia Perspectives :
According to Islamic Finance Guru, as the activity of racing with other miners with computational power to "solve" the puzzle, mining is intrinsically not haram. As for staking as a concept is not Islamically problematic as well. It is simply a rule-based approach used by a crypto project to decide who will get the right to add to the blockchain.
There are a few important caveats to make here about staking:
Each crypto project has its own specific staking dynamics and so the particular rules of a crypto project may not necessarily be sharia-compliant if they throw in something novel. However, if they use very straightforward staking concepts, that should be fine.
Staking is just a mechanism of creating new coins in a crypto project. You also need to make sure that the crypto project itself is sharia-compliant. So, for example, if a crypto project links itself directly with gambling, then regardless of how it uses staking, it will be impermissible.
Some may argue what if the transactions that will be validated / added to the blockchain by validators or miners are ribawi transactions, gambling, money laundering, or used for other crimes. Well, the existence of various transactions being validated does not necessarily make validation activities haram unless it is known that the transaction is completely haram or mostly haram. And as far as we know, we absolutely cannot choose and do not know what type of transaction will be validated by the miner/validator. This can be compared to internet service server providers where they cannot filter online crimes committed by their users. So, back to the basic principle of law in muamalat: mubah. Wallahu a'lam
Referensi Bacaan :
III. Airdrop
Airdrops are essentially freely distributed tokens. Projects usually conduct airdrops as part of their marketing strategy to generate attention and hype around their token launch, albeit with the tradeoff of diluting token ownership.
Some projects also conduct airdrops to reward early adopters who have interacted with their protocols. Each protocol will have criteria for qualifying airdrop recipients, such as the timing of interaction and minimum usage frequency.
Sharia Perspectives:
Based on how to have it, it is permissible to participate in an airdrop event to get free coins/tokens as long as the terms of conditions for getting them are not problematic from a sharia perspective. If the coins/tokens rewarded are classified as impermissible assets based on the substances, then it should be avoided. And Allah knows best.
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