Why Liquidity Mining Attracts the Wrong Kind of Users

Liquidity mining creates a principal-agent problem where farmer incentives diverge from protocol health. Farmers optimize for highest APY and lowest risk, leading to rapid capital flight.\n- Goal: Extract maximum emissions before the next farm.\n- Result: >80% TVL churn post-program end, as seen with SushiSwap and early Compound pools.

Programs like SushiSwap's initial fork weaponize liquidity mining to drain a competitor's TVL, forcing a defensive, inflationary response. This triggers a race to the bottom in token emissions.\n- Mechanism: New protocol offers higher yields to siphon liquidity.\n- Consequence: Both protocols inflate their token supplies, diluting holders and creating unsustainable emission schedules.

Mining rewards are often paid for providing low-quality, imbalanced liquidity on Automated Market Makers (AMMs). This attracts loss-versus-rebalancing (LVR) arbitrage, where farmers' profits are subsidized by regular traders.\n- Reality: Farmers provide liquidity that is instantly arbed, creating negative externalities.\n- Outcome: Protocol pays for phantom liquidity that offers poor execution and increases slippage for real users.

Programs create a rent-seeking user base that chases the highest APY, leading to extreme volatility. This results in a negative-sum game for the protocol treasury.

• TVL collapses by 50-90% post-incentives, as seen with early SushiSwap and Compound forks.
• Token price becomes a function of emissions, not utility, creating a death spiral.
• Real users get priced out by inefficient capital allocation and inflated token supply.

Shift from bribing LPs to aligning them via vote-escrow models (e.g., Curve, Balancer) and protocol-owned liquidity (e.g., OlympusDAO). This creates sticky, long-term aligned capital.

• Locked tokens (veCRV) grant governance power and boosted rewards, penalizing quick exits.
• Protocol Controlled Value (PCV) insulates the treasury from mercenary capital flight.
• Focus shifts to fee generation and sustainable yields, not inflationary subsidies.

Permissionless farming invites Sybil attackers to farm rewards with multiple wallets, diluting genuine users. This directly compromises network security and decentralization.

• Airdrop hunters exploit programs, as seen with EigenLayer and Arbitrum, forcing teams to implement complex clawbacks.
• Governance is hijacked by farming conglomerates, not genuine stakeholders.
• Creates a tax on honest users who subsidize the attackers' rewards.

Reward verifiable on-chain activity, not just capital parked in a pool. Implement retroactive airdrops (Optimism, Uniswap) and point systems based on fees paid or volume generated.

• Target real users: Reward based on fee generation or transaction volume, not TVL.
• Loyalty tiers: Use time-based multipliers (e.g., Blur's holding periods) to reward persistence.
• Leverage attestation protocols like Ethereum Attestation Service (EAS) to prove unique humanity and usage.

Incentives are a blunt instrument that often subsidize the wrong actions (e.g., wash trading) and make protocols vulnerable to vampire attacks (e.g., SushiSwap vs. Uniswap).

• Emissions outpace real demand, leading to massive sell pressure from farmers.
• Attracts copycat forks that drain liquidity the moment incentives dry up.
• Distorts oracle prices and MEV opportunities, harming the broader DeFi stack.

Use directed incentives for specific, high-value actions (e.g., lending uncorrelated assets) and bonding curves (e.g., Bancor v3) to manage liquidity depth programmatically.

• Subsidize tail assets or new market creation, not established blue-chip pools.
• Dynamic emissions that adjust based on fee revenue or utilization rates.
• Bonding curves provide single-sided, impermanent loss-protected liquidity, reducing farmer dependency.