How Does Liquidity Mining Work?

Now, let’s take a look at how liquidity mining works in the DeFi markets.

• A trading protocol, such as Uniswap, provides two tokens, X & Y, in an autonomous liquidity pool for trading.

• Trading requires liquidity in both tokens to ensure users can buy and sell the two tokens without significant price slippage. Liquidity providers deposit equal proportions of tokens X and Y into their liquidity pools to ensure that there’s ample liquidity for that.

• Trading continues within the pool as users swap token X for Y and vice versa. Every trader pays a trading fee (in addition to network fees) for token swapping.

• The protocol then distributes the fees (paid in the liquidity pool tokens) to liquidity providers, proportional to their deposited funds. Additionally, liquidity mining rewards are paid in the protocol’s governance tokens. In the case of Uniswap, that would be UNI.

• If there is an imbalance between the two tokens, the AMM adjusts its prices accordingly to encourage more investors to input liquidity into the pool.

To cash out the fees and rewards, liquidity providers must withdraw their assets from the trading pools back into their personal crypto wallets.

ref: https://unchainedcrypto.com/what-is-liquidity-mining/