--- title: "Liquidity mining and mercenary capital" url: "https://caper.network/wiki/economics/liquidity-mining" updated: 2026-09-02 license: CC-BY-4.0 license_url: "https://creativecommons.org/licenses/by/4.0/" --- # Liquidity mining and mercenary capital | Concept | Liquidity mining (yield farming) | | --- | --- | | Category | Token incentives / DAO tokenomics | | Introduced | June 2020 — [Compound](https://docs.compound.finance/governance/) COMP distribution ("DeFi summer") | | Mechanism | Protocol emits its governance token to liquidity providers on top of trading fees, to bootstrap TVL | | Core failure mode | Mercenary capital — rented liquidity that exits when emissions fall | | Common responses | [Vote-escrow (ve) tokenomics](/wiki/dao-governance/concepts/voting/vote-escrow), [protocol-owned liquidity](/wiki/dao-governance/concepts/treasury/protocol-owned-liquidity) | **Liquidity mining** (also called _yield farming_) is a token-distribution strategy in which a protocol pays out its own governance token to the users who supply liquidity or otherwise use it. The rewards sit on top of ordinary trading fees or lending interest, so for a period the protocol effectively subsidises participation with newly minted tokens. It is the most widely copied DAO growth mechanism of the last five years, and also one of the most criticised: it reliably buys total value locked (TVL) in the short run, and reliably fails to keep it. Liquidity mining is one of the two ways a DAO gives its token away, and it is useful to hold them side by side. It pays continuously, prospectively, and for a specific behaviour it wants more of; an [airdrop](/wiki/economics/airdrops-and-token-distribution) pays once, retroactively, for behaviour that has already happened. The two share a failure mode — a large share of the distributed token is sold on receipt in both cases — but they fail on different clocks. An emissions programme keeps buying the same capital every day until it stops paying; an airdrop finds out in a single week whether it bought anything at all. ## Origin: Compound and "DeFi summer" Liquidity mining as a mass phenomenon dates to June 2020, when [Compound](https://docs.compound.finance/governance/) began distributing its governance token COMP daily to both suppliers and borrowers across its money markets, in proportion to the interest accruing in each market. Within a day COMP was among the largest DeFi tokens by market capitalisation, and the design was copied across the ecosystem in what became known as "DeFi summer." The insight was simple: instead of selling tokens to investors, a protocol could distribute them to the people actually using it, bootstrapping both liquidity and a holder base at once — a [user-centric distribution](https://multicoin.capital/2020/08/13/exploring-the-design-space-of-liquidity-mining/) in place of a sale. ## How it works The mechanics are consistent across implementations: - **Deposit.** A user supplies assets to a pool — a lending market, or a two-sided [AMM](/wiki/economics/capital-markets) pool. - **Accrue.** The protocol streams a fixed or governance-set number of its tokens per block/day to that pool, split across depositors by share. - **Claim and, usually, sell.** Farmers harvest the reward token. Because most farmers value the reward only in the numéraire they came with, a large share is sold on receipt, adding constant sell pressure. The headline number is APY: the annualised value of emissions divided by capital deposited. When the reward token appreciates, that APY can spike — Compound's reached roughly 50% at points — which is exactly what pulls in capital that has no interest in the protocol beyond the yield. High [token velocity](/wiki/economics/token-velocity) (reward tokens earned and immediately dumped) is the direct on-chain signature of this dynamic. ## The mercenary-capital problem _Mercenary capital_ is liquidity that chases the highest available yield with no loyalty to any one protocol. It arrives when a program launches and leaves the moment emissions taper or a richer farm appears elsewhere. The consequence is that TVL, during an incentive program, measures the size of the incentive far more than the health of the protocol: a chart of deposits often tracks the emissions schedule almost exactly, then collapses when rewards end. The extreme cases — pools that amassed a meaningful slice of all DeFi TVL over a single weekend and then emptied — made the pattern impossible to ignore. The costs compound. Emissions dilute existing holders to pay for liquidity that does not stay; the sold reward tokens depress price; and the protocol is left with a temporary TVL number and no durable moat. Liquidity mining is best understood not as free growth but as **renting** liquidity — and rented liquidity leaves. ## Steering emissions: vote-escrow and gauges The first major refinement was to make emissions _earned_ and _directed_ rather than sprayed. [Curve](/wiki/daos/dexs/curve-dao)'s design is the archetype: liquidity providers still receive CRV emissions, but the split across pools is decided by [gauge-weight votes](https://docs.curve.finance/protocol/gauge/overview) cast by holders who have locked CRV into [vote-escrowed veCRV](/wiki/dao-governance/concepts/voting/vote-escrow). Locking longer grants more weight, converting some mercenary capital into longer-committed capital and letting governance point rewards at the pools that matter. It also spawned a secondary market — "bribes" and vote markets where protocols pay veCRV holders to direct emissions their way — which is a story in its own right (the "Curve wars"). The lesson: emissions are a lever, and who holds the lever is a governance question. ## Owning liquidity instead of renting it The second response was to stop renting altogether. Rather than pay emissions to third-party LPs forever, a DAO can acquire the liquidity for its own balance sheet — [protocol-owned liquidity](/wiki/dao-governance/concepts/treasury/protocol-owned-liquidity) (POL). [OlympusDAO](/wiki/daos/stablecoins/olympusdao) popularised the approach with bonding: the protocol sells its token at a discount in exchange for LP tokens, building a treasury of liquidity it controls and no longer has to keep bribing to retain. A [liquidity bootstrapping pool](/wiki/economics/liquidity-bootstrapping-pools) solves the adjacent problem of the initial fair launch, though the reference implementation of that format has itself been switched off: Balancer disabled its v2 LBP factory on-chain in May 2026, and the v3 successors had produced 21 non-mock pools across Ethereum mainnet, Base and Arbitrum as of 19 August 2026. Each of these trades an ongoing emissions bill for a one-time treasury cost, and each treats liquidity as an asset to hold rather than a subsidy to pay. The third response is to stop paying and start collecting: a [fee switch](/wiki/economics/fee-switches-and-value-accrual) reverses the direction of the flow, taking a slice of the fees liquidity providers earn and routing it to the protocol. Uniswap ran both experiments in sequence — years of emissions-led growth, then a protocol fee that pays for token burns out of LP revenue. ## Design tradeoffs Multicoin Capital's [design-space analysis](https://multicoin.capital/2020/08/13/exploring-the-design-space-of-liquidity-mining/) frames the choices well: _who_ gets paid (makers, takers, or service providers like liquidators), _how much_ (total allocation and how it is measured), and _when_ (immediate, vested, or clawback-able). A program that pays a fixed emission with no lock-up should expect short-term arbitrageurs to crowd out organic users; lock-ups, vesting, and usefulness-weighted rewards push in the other direction. The recurring failures are the mirror image: overpaying for headline TVL, rewarding volume rather than usefulness, and emission rules loose enough to be gamed. Liquidity mining is not inherently bad — it is a distribution tool whose outcome is entirely determined by these parameters and by whether the protocol has a reason for the capital to stay once the subsidy stops. ## How Caper approaches this A [Caper](/wiki/foundations/what-is-a-caper) runs no liquidity-mining program and emits no reward token. Instead of renting liquidity with emissions, each caper's token trades against an always-on [bonding curve](/wiki/markets/bonding-curve) whose reserve provides continuous liquidity at the curve price — there is no third-party LP to bribe and no emission schedule to taper. Governance weight is not farmed either: the soulbound vote tokens that price an exit are minted by [trading](/wiki/markets/trading) itself, 0.01 per XRD of gross trade value on buys and sells alike, and by [voting](/wiki/governance/voting), one per ballot cast – so every holder who has taken part keeps a credible [exit right](/wiki/dao-governance/concepts/membership/rage-quit-and-exit-rights) to redeem their share of the treasury. The contrast is the point of this page — liquidity mining buys capital that leaves when the reward stops; Caper's design gives capital a standing reason to stay, or a clean way to go, without a subsidy running underneath it. ## References - [Compound — Governance and COMP distribution (docs)](https://docs.compound.finance/governance/) - [Tushar Jain & Spencer Applebaum, Exploring the Design Space of Liquidity Mining (Multicoin Capital, 2020)](https://multicoin.capital/2020/08/13/exploring-the-design-space-of-liquidity-mining/) - [Curve — Gauges & incentives overview (docs)](https://docs.curve.finance/protocol/gauge/overview)