> ## Documentation Index
> Fetch the complete documentation index at: https://docs.theblockchainlibrary.com/llms.txt
> Use this file to discover all available pages before exploring further.

# Liquidity Mining

> The distribution of tokens or other incentives to users who provide liquidity to a decentralized protocol.

# Liquidity Mining

The distribution of tokens or other incentives to users who provide liquidity to a decentralized protocol.

## Definition

The distribution of tokens or other incentives to users who provide liquidity to a decentralized protocol.

## Why it matters

DeFi concepts explain blockchain-based markets, lending, trading, liquidity, and financial automation.

## How it works

Users deposit crypto assets into a smart contract vault, which pools them to provide liquidity for trades. The protocol monitors these deposits and distributes governance tokens proportional to the value provided. Participants can then stake or sell these earned tokens for additional profit.

## Real-world example

Uniswap and Compound are classic examples where users earn UNI or COMP tokens respectively for providing liquidity to the platform's pools.

## Advantages

* Provides passive income for liquidity providers
* Bootstraps network effects for new protocols
* Distributes governance power to users

## Limitations

* High risk of impermanent loss
* Vulnerable to yield farming volatility
* Smart contract security vulnerabilities

## Common misconceptions

* Many believe it is a guaranteed profit scheme without risk. It is actually subject to market volatility and technical failures.
* Some assume it is exactly the same as traditional staking. Mining requires providing capital that is actively used for trading.

## Related knowledge

* [Smart Contract](/generated/v2/glossary/smart-contract) — term

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**Canonical knowledge ID:** `glossary:liquidity-mining`