Liquidity Mining

Liquidity mining is an incentive program in which a protocol distributes its own tokens to users who supply liquidity, effectively paying people in newly issued tokens to bootstrap trading depth. It is a specific form of yield farming: the 'mining' is not computational work but the act of providing capital, rewarded with token emissions on top of ordinary trading fees.

The canonical example is Compound's launch of its COMP token in June 2020, which distributed COMP to lenders and borrowers and set off the DeFi Summer boom. A typical setup today looks like this: a new decentralized exchange wants deep markets, so it announces that anyone providing liquidity to selected pools will earn its governance token on top of pool fees, at a rate proportional to their share of the pool and the time they stay.

For protocols, liquidity mining solves a cold-start problem — markets need liquidity to attract traders, and traders to make liquidity worthwhile. A common misconception is that these rewards are sustainable income; emissions usually decline over time, and much of the capital they attract is mercenary, leaving as soon as rewards drop. Participants should also weigh the usual liquidity provider risks, especially impermanent loss and the tendency of farmed tokens to fall in price as recipients sell them.