The Evolution of Liquidity Miners: From Speculative Mercenaries to Infrastructure Providers
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The Evolution of Liquidity Miners: From Speculative Mercenaries to Infrastructure Providers
DeFi offers not only lending, trading, and derivatives, but also yield farming—a truly innovative feature unique to DeFi.
Navigating Web3 tides with focused insightsAuthor: LilyKing from Boundary, current COO of Cobo, a lawyer in both China and the U.S., deeply researching social policies, collaboration mechanisms, and cooperative architectures.
Abstract
Liquidity is the infrastructure of DeFi. Just as Bitcoin miners provide computational power that serves as Bitcoin's infrastructure, DeFi capital providers focused on liquidity mining (leading teams in the industry include SBF’s Alameda Research and Shenyu’s Defi As a Service - DAAS fund) are also infrastructure providers for DeFi.
Liquidity mining is a profit model unique to the crypto world, making it less intuitive to traditional finance than VC models. However, compared to VC, it offers a superior risk-return profile. It can employ market-neutral strategies to protect principal while acquiring new project tokens at low cost, capturing growth opportunities. Currently overlooked by the market, this profit model represents a rare blue-ocean opportunity.
Liquidity mining requires many high-barrier professional skills—from auditing smart contracts and monitoring on-chain data to tracking hacker risks, maximizing capital efficiency, and managing multisig wallets. Elite crypto-native teams, leveraging years of on-chain intelligence analysis and实战 experience, hold significant advantages over traditional financial capital outside the ecosystem.
Liquidity mining is becoming increasingly team-based and institutionalized, building advantages in capital, information, and technology—but these teams may not take the form of traditional companies, instead existing as DAOs.
The relationship between liquidity mining and DeFi protocols is evolving from short-term speculative capital into long-term infrastructure partnerships. DeFi funds will collaborate with truly promising protocols in a DAO-to-DAO manner, providing sustained liquidity to support their growth, participating in governance as token holders, and maximizing returns from token appreciation.
Main Text:
Liquidity miners are an important yet mysterious force in the DeFi world—far less visible than app developers or venture capitalists, but without them, DeFi protocols cannot function. Without liquidity—enough tokens to support smooth trading—DeFi protocols are merely lines of code rather than usable applications. Liquidity miners are core participants in DeFi whose investment strategy centers on providing liquidity to various DeFi protocols, enabling them to capture most of the protocol’s profits while acquiring governance tokens at very low cost (even lower than venture capital).
In this article, I will analyze the unique role liquidity miners play within the DeFi ecosystem and explore what their next evolution might look like.
What Is Liquidity Mining?
The magic of DeFi protocols lies in their ability to support diverse financial activities—payments, lending, borrowing, and trading—without the expensive and complex intermediaries of traditional finance. At their core, they are smart contracts enabling peer-to-peer transactions, open to anyone. For example, leading DEXs (decentralized exchanges) mostly use the AMM model (Automated Market Maker), where protocols establish liquidity pools using user-provided tokens. Users then trade tokens via these pools and automated protocols. In traditional securities exchanges, capital provision is highly concentrated among large institutions; DeFi decentralizes this function.
To ensure smooth trading with minimal price slippage, DeFi protocols require sufficient liquidity (adequate quantity and variety of tokens). This is why the emergence of liquidity mining—a mechanism incentivizing liquidity providers—played a crucial role in launching the 2020 DeFi Summer, during which total value locked (TVL) in DeFi surged from $800 million in April to $10 billion in September. Today, nearly all DeFi protocols offer liquidity mining incentives at launch.
Liquidity mining programs typically offer two types of rewards: trading fees and governance tokens. First, the majority of trading fees collected by DEXs go directly to liquidity miners. Take leading DEX Sushiswap as an example: it charges a 0.3% fee per transaction, with 0.25% going to liquidity providers and 0.05% to token holders. Additionally, liquidity providers receive Sushi Token rewards. Sushi didn’t even have a token sale open to venture capital—all its tokens were distributed through liquidity mining programs.
Some protocols do allocate tokens to founding teams, early investors, and liquidity providers. Typically, such protocols reserve 30–40% of their tokens for liquidity mining programs. For instance, XY Finance, a cross-chain transaction aggregator that publicly launched its token on December 9, allocated 35% of its tokens to liquidity mining, while its VC investors collectively received 24% from seed to strategic rounds.
Liquidity miners indeed gain substantial benefits from protocols. They can even adopt market-neutral strategies—providing only stablecoins like USDC and USDT or hedging their token positions—while still capturing most of the protocol’s revenue and receiving free tokens.
The Secrets of Elite Liquidity Miners
Liquidity mining is open to everyone, but there’s certainly no free lunch. DeFi remains an unregulated Wild West—if you interact with a fraudulent or hacked DeFi protocol, you could lose all your funds with no recourse. Meanwhile, liquidity mining is a unique mechanism found only in DeFi, one that traditional finance players struggle to understand as a profit-making strategy.
I’ve had the opportunity to work with some of the most experienced liquidity mining teams actively playing this game. I’ve observed that top performers have developed rich expertise to maximize their gains from liquidity mining, including:
1) How to audit smart contracts to identify potential scams or vulnerabilities
2) How to assess hacking risks
3) How to monitor on-chain data to track a protocol’s financial health
4) How to track “DeFi Whale” wallets whose movements may influence markets
5) How to allocate funds across various protocols to manage risk and return
6) How to maximize capital efficiency by leveraging lending protocols and auto-compounding
7) How to set up multi-layered multisig wallets that support team collaboration and rapid response
All of the above crypto-native expertise remains largely unfamiliar to traditional investors. Despite seeing billions in traditional capital flow into crypto assets recently, investment opportunities around liquidity mining remain largely overlooked—this is still a rare blue ocean.
The End of Mercenary Capital
The outlook for liquidity mining isn’t entirely rosy—it’s far from a perfect solution to DeFi’s liquidity challenges. If a protocol continuously rewards liquidity miners with large amounts of its own tokens, its token value will inevitably be diluted. Conversely, if a protocol reduces or stops token rewards, liquidity miners may simply move to other protocols offering higher rewards.
In fact, liquidity miners have historically acted primarily as mercenary capital—constantly shifting to whichever protocol offers the highest rewards, often dumping their quickly earned tokens to avoid dilution from ongoing incentive programs.
This unstable dynamic often leads to a lose-lose situation: when liquidity miners begin selling off a protocol’s tokens, prices drop, reducing the appeal of the mining incentives, prompting miners to leave, draining liquidity, and rendering the protocol unusable.
These flaws in the liquidity mining mechanism have driven innovation on the protocol side. Olympus Dao, a pioneer of DeFi 2.0, introduced the concept of POL (Protocol-Owned Liquidity), designing a bond mechanism that offers its own tokens at a discount in exchange for liquidity tokens. Protocols adopting this model gain control over their liquidity rather than renting it from miners. Meanwhile, many protocols are adjusting their incentive structures to require liquidity miners to lock up earned tokens for a period.
More and more liquidity miners now recognize that long-term win-win relationships with DeFi protocols are key to maximizing returns. They’re beginning to communicate directly with protocol developers, discussing ways to collaborate and support protocol growth. Already holding governance tokens, they’re increasingly active in governance—from voting to drafting proposals. This means liquidity miners are taking on some responsibilities akin to venture capitalists, betting on protocols they believe in and supporting their development.
The changing landscape is also helping more liquidity miners recognize the benefits of pooling capital and knowledge. Liquidity mining is becoming a team sport. When liquidity miners organize, they naturally gravitate toward crypto-native forms—DAOs (Decentralized Autonomous Organizations). Early examples already exist, such as Don Key Finance—a social platform allowing newcomers to copy experts’ strategies—or Aladdin Dao—a community investing together in protocols handpicked by DeFi masters. Both projects have issued their own tokens to incentivize active DAO members.
Since DAOs are already the primary organizational form behind many DeFi protocols, we can expect increasing DAO-to-DAO collaboration between protocols and liquidity miners.
Liquidity Miners as Infrastructure Providers
Liquidity mining closely resembles Bitcoin mining in many ways—both liquidity miners and Bitcoin miners provide critical infrastructure for the blockchain world. Bitcoin miners contribute computing power to process transactions on the Bitcoin blockchain and are rewarded with Bitcoin. Liquidity miners contribute capital to support transactions on DeFi protocols and are rewarded with governance tokens. We’ve seen several Bitcoin mining companies go public, as mainstream investors now understand their business models. Yet, the potential of liquidity mining remains undervalued.
One of the most compelling visions of blockchain is the “Internet of Value.” For value to be transferred, liquidity is essential infrastructure.
Many applications in DeFi are merely on-chain replicas of things we know well in traditional finance—from lending and trading to derivatives. Holding or trading tokens isn’t fundamentally different from how people handle assets in traditional finance. But DeFi offers more than just replication—liquidity mining is a truly innovative feature unique to DeFi. Its emergence reminds us that DeFi will bring entirely new investment forms that cannot fit within traditional financial frameworks.
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