Thoughts on Liquidity Mining

I've been thinking about liquidity mining a lot recently so thought I would try and capture some of my thoughts.


I’ve been an active liquidity miner since Compound started up in June 2020. As a accumulator, I generally keep everything I earn add it to my list of bags.

More recently I’ve been involved in the INDEXcoop and many discussions on liquidity mining on Uniswap, Loopring and Sushiswap. I’ve come to realise that Liquidity mining takes many forms.

Note: when I started writing this piece, I found Dmitrty Berenzon’s excellent blog on the same subject. I recommend it to anyone reading this, and I’ll try and taker a different approach to the subject.

What is liquidity Mining?

Liquidity mining is when a protocol provides incentives to users who provide liquidity.

The liquidity is generally in the form of assets outside the protocols control (e.g. $ETH) and often provided in a protocols native / governance token.

Note, I would not consider staking 100% of the governance token in reward for income as the same token to be liquidity mining, rather it is a mechanism to lock up the circulating supply.

Why would a protocol do liquidity mining?

To boot strap a capital intensive operation. e.g. options trading protocols requiring $ETH or $wBTC, or a DEX building AMM pools (Hegic, SynLev)

To encourage adoption of a product and grow AUV. e.g. index funds, or income generating vaults (INDEXcoop, Yearn, Rari)

To maintain large, long term, liquidity pools to attract and retain larger trades where normal trading fees may be insufficient to maintain the size of the pool (Curve, Compound).

To battle test a protocols contracts with large AUV, in order to help the market gain confidence in the protocol (all ?). Users are much more likely to use a Vault that has contained $20 M for a couple of months than one that has $500 K in it.

To raise the protocols profile after launch of the token - Marketing (all)

To engage with another protocols community - making a non productive governance token productive by giving your tokens generates goodwill and attracts attention (YAM).

To recruit new community members as a protocol grows and establishes itself - critical if the plan is to “exit to community”

To distribute governance tokens in a fair and transparent way (often to those with the deepest pockets) and so help a protocol become decentralised) - (All governance token rewards).

To get tokens onto the open market due to the actions of purely profit seeking liquidity miners - i.e. not those who would buy and hold the token long term.

What forms of liquidity mining are there?

The majority of liquidity mining program relate to staking AMM pool tokens. This helps the protocol by:

  • Distributing tokens

  • Providing liquidity for market buyers

  • Helping price discovery by having a large liquidity pool

  • Compensating for the potential divergence losses that AMM LP’s are exposed to (particularly for small market caps)

  • Preventing token holder from immediately selling by (temporarily) placing them in the pool.

This is normally done with a standard staking contract deployed by the LM protocol, however the Sushiwasp Onsen program makes it easier to outsource the coding to the Sushi team, and can benefit from both the native token and Sushi rewards.

The other main type of LM is protocols wanting a large asset base ($ETH, $wBTC, or stablecoins) to kick start operations. Here the liquidity provider may face opportunity cost (Barnbridge) or the loss of part of the asset provided (Syndev and Hegic) and so the incentives offset this risk / cost while the protocol grows and fine tunes it’s systems to become self sustaining.

The final type is where the locked assets are not used in any productive way, but the protocol sees a benefit in terms of token distribution, marketing, and attracting the holders of tokens with like minded / complementary communities.

Where to find liquidity miking opportunities

Coingecko have a farming table where opportunities can be found:

In addition, crypto twitter can be an useful source, but be careful to avoid psyops (dishonest promoting of farms). Finally there are a number of crypto publications that cover farming opportunities including the Defi Pulse Yield farmer blog

What are the risks / costs?

  • Straight asset pools may return less than deposited (particularly for options protocols)

  • AMM pools can suffer divergence loss. This is likely larger for pools that include stable coins or small market cap tokens.

  • All liquidity provision suffers from opportunity costs - could you get better yields elsewhere?

  • Liquidity provision exposes your assets to more smart contracts and risks of exploits.

  • Deliberate rug pulls by protocols can be done when the protocol controls significant aspects of the mining programme (e.g. minting contract for a token in a AMM pool).

  • Being an active farmer can be expensive, gas will be used to authorise tokens, deposit tokens into AMM pools, deposit tokens / LP tokens into staking contracts, claiming rewards, unstaking, and exiting liquidity pools.

    • Currently this may add up to ~$200 and so liquidity mining is normally only profitable when you have a significant assets available ($5,000 minimum ?).

    • Some protocols use modified systems to reduce the gas costs for users by air dropping tokens onto stakers / into AMM pools.

    • Loopring AMM’s have the benefit of gasless operations and airdropped reward (but it costs gas to get onto L2)

Automated options

Some protocols create vaults that use users assets to farm different liquidity mining opportunities. These include:

  • Yearn.finace - Generally long term stable coin or major token ($ETH, $wBTC) farms

  • Harvest and Pickle - often shorter liquidity mining farms which sell the reward token.

  • Alpha Homora - Which liquidity mines with leverage, the forth coming v2, will stop routing market selling of tokens as they are collected.

Final Thoughts

Most liquidity mining campaigns are inherently unsustainable, the protocol is effectively giving away (hopefully) valuable governance tokens, in return for fulfilling short term goals. Even so there are exceptions (like Curve) where long term liquidity mining is planned.

Over time liquidity mining programmes are getting more complex (Curve, Badger) with multiple options available with different outcomes . This is a trend I expect to continue.

Many projects kick off with a combination of liquidity mining and air drops (to reward early adopters, like minded token holders, or even gitcoin grant donors). Again the aim is to often attract attention, community members, and provide a kick start to open market liquidity.

It’s obvious that liquidity mining programmes (and air drops) need to be designed with care and consideration of the protocols objectives.

Finally, go and read Dmitiry’s blog, it really is very good.

Disclosure and Disclaimer

I’m a long term investor in crypto currencies including DeFi. I am an active member of the INDEXcoop which manages the $DPI fund.

This is not financial advice, all investments are risky, crypto investments are more risky than most. Do your own research. Do not invest more than you can afford to lose.

@over-analyser on twitter