Liquidity Mining Complete Guide

Liquidity Mining is one of the most popular passive income methods in DeFi. By providing liquidity, you can earn trading fees and token rewards. However, this isn't a risk-free investment—understanding the mechanics and risks is crucial.

What is Liquidity Mining?

Basic Concept

In traditional exchanges, buyers and sellers are matched through order books. But in decentralized exchanges (DEXs) like Uniswap, trading happens through "liquidity pools."

A liquidity pool is like a fund pool containing pairs of tokens (e.g., ETH and USDC). When someone wants to swap ETH for USDC, they trade directly with the pool instead of finding another person who wants to sell USDC.

Liquidity Providers (LPs) are people who deposit their tokens into these pools. In return, LPs receive:

A share of trading fees from each transaction
Additional token rewards from the platform

Automated Market Maker (AMM) Mechanics

Most DEXs use the "constant product formula":

x × y = k

Where:

x = Amount of Token A in the pool
y = Amount of Token B in the pool
k = Constant value

This formula ensures the pool always has liquidity while automatically adjusting prices based on supply and demand.

Tip

When someone buys a large amount of a token, that token decreases in the pool, causing its price to rise. This is how "slippage" occurs.

Impermanent Loss: The Risk You Must Understand

Danger

Impermanent Loss is the biggest risk in liquidity mining! Make sure you understand this concept before providing liquidity.

What is Impermanent Loss?

When the price ratio of your two deposited tokens changes, your asset value becomes less than if you had simply held those tokens. This is impermanent loss.

Impermanent Loss Calculation Example

Suppose you provide 1 ETH + 2000 USDC to a liquidity pool (when ETH = $2000).

Scenario 1: ETH rises to $4000

Strategy	Final Value
Simply holding	1 ETH ($4000) + 2000 USDC = $6000
Providing liquidity	~0.707 ETH + 2828 USDC = $5656
Impermanent Loss	$344 (5.7%)

Scenario 2: ETH drops to $1000

Strategy	Final Value
Simply holding	1 ETH ($1000) + 2000 USDC = $3000
Providing liquidity	~1.414 ETH + 1414 USDC = $2828
Impermanent Loss	$172 (5.7%)

Impermanent Loss Reference Table

Price Change	Impermanent Loss
±25%	0.6%
±50%	2.0%
±75%	3.8%
±100%	5.7%
±200%	13.4%
±300%	20.0%
±400%	25.5%

Warning

The more volatile the prices, the higher the impermanent loss. Providing liquidity is only profitable when fee income exceeds impermanent loss.

How to Minimize Impermanent Loss?

Choose Stablecoin Pairs
- USDC/USDT, DAI/USDC pairs have almost no impermanent loss
Choose Highly Correlated Token Pairs
- ETH/stETH, BTC/WBTC pairs where prices move together
Use Concentrated Liquidity
- Uniswap V3 allows setting price ranges for higher capital efficiency
Consider Single-Sided Liquidity
- Some protocols allow providing only one token

Practical Guide: Providing Liquidity on Uniswap

Preparation

Prepare Wallet: MetaMask or another Web3 wallet
Prepare Tokens: Equal value of both tokens
Prepare Gas Fees: Enough ETH for transaction fees

Step 1: Go to Uniswap

Open app.uniswap.org
Connect your wallet
Click the "Pool" tab at the top

Step 2: Create a New Position

Click "+ New Position"
Select the token pair you want to provide (e.g., ETH/USDC)
Select the fee tier:
- 0.01%: Stablecoin pairs
- 0.05%: Highly correlated pairs
- 0.30%: Most standard pairs
- 1.00%: Highly volatile pairs

Tip

The fee tier affects how much trading fees you earn, but higher fee pools may have less trading volume. Generally, choose the tier with the highest trading volume.

Step 3: Set Price Range (Uniswap V3)

This is Uniswap V3's signature feature—concentrated liquidity:

Minimum Price: The lowest price at which you'll provide liquidity
Maximum Price: The highest price at which you'll provide liquidity
Full Range: Click "Full Range" to provide liquidity across all prices

Range Setting Recommendations:

Strategy	Range Setting	Characteristics
Conservative	Wide range (±50%)	Less management, lower yields
Aggressive	Narrow range (±10%)	High yields, requires frequent adjustment
Stablecoin	Very narrow range (±1%)	Stable yields, low risk

Warning

When the price moves outside your set range, your liquidity won't be used and won't earn fees. Also, your assets will be entirely converted to one token.

Step 4: Enter Amount and Confirm

Enter the amount of one token
System automatically calculates the other token amount needed
Review estimated fee earnings
Confirm all information is correct
Click "Preview"
Review transaction details
Click "Add" and confirm in your wallet

Step 5: Manage Your Position

After providing liquidity, you can:

View Position: See all your positions on the "Pool" page
Collect Fees: Accumulated fees can be collected anytime
Adjust Range: Close old position and open new one with different range
Remove Liquidity: Withdraw your tokens anytime

Advanced Strategies: Liquidity Mining Platforms

Beyond Uniswap's native fee income, many platforms offer additional token rewards:

Curve Finance

Features:

Focuses on stablecoin swaps
Very low impermanent loss
CRV token rewards
Lock tokens for higher yields

Suitable for: Investors preferring stable returns

Convex Finance

Features:

Built on top of Curve
Amplifies Curve yields
No need to lock CRV yourself
CVX token rewards

Suitable for: Those wanting higher yields without managing Curve locks

Balancer

Features:

Supports multiple token combinations (not just two)
Customizable token weights
BAL token rewards

Suitable for: Investors wanting more flexible allocation

PancakeSwap (BSC)

Features:

Runs on BNB Chain
Very low gas fees
CAKE token rewards
High APR but token may depreciate

Suitable for: Beginners wanting to try liquidity mining with small funds

Yield Calculation

Total liquidity mining yield includes:

1. Trading Fees

Fee Income = Daily Trading Volume × Fee Rate × (Your Liquidity / Total Liquidity)

2. Token Rewards

Token Rewards = Annual Rewards × (Your Liquidity / Total Liquidity)

3. Annual Yield (APR vs APY)

APR: Annual yield without compounding
APY: Annual yield with compounding

Tip

Projects showing extremely high APY usually calculate the reward token's current price into the rate. If the token price drops, actual returns will be much lower.

Risk Management

Danger

Liquidity mining has multiple risks—it's not guaranteed profit!

Risk Checklist

Impermanent Loss
- Losses from token price changes
- More volatile pairs have higher risk
Smart Contract Risk
- Contracts may have vulnerabilities that get hacked
- Choose well-known, audited protocols
Token Value Risk
- Reward tokens may significantly depreciate
- Regularly harvest and convert to stable assets
Gas Fee Risk
- Ethereum gas can be very high
- Small amounts may not be worthwhile
Opportunity Cost
- Funds locked in liquidity pools
- May miss other investment opportunities

Risk Management Recommendations

Diversify: Don't put all funds in one pool
Choose Blue-Chip Protocols: Prioritize high-TVL, long-standing protocols
Harvest Regularly: Don't let rewards accumulate too much
Set Stop-Loss: Decide on maximum acceptable loss
Keep Learning: Follow DeFi security news

Summary

Liquidity mining is a potentially lucrative passive income method, but requires understanding the risks:

Liquidity mining is suitable for:

Those who understand and can accept impermanent loss
Those willing to spend time learning and managing
Those with sufficient funds to cover gas fees
Those who can afford to lose their principal

Liquidity mining is NOT suitable for:

Investors seeking stable, principal-protected returns
People without time to monitor the market
Small funds operating on Ethereum mainnet
Beginners unfamiliar with basic DeFi concepts

Beginners should start with stablecoin pairs, use small amounts to practice, and gradually increase investment once familiar with the process.

Get Started

Ready to participate? First buy cryptocurrency on an exchange:

Want to learn more DeFi strategies? Continue reading: