What Is the Incentive Structure for a Liquidity Provider (LP) in a Typical AMM?
The primary incentive for a Liquidity Provider (LP) is to earn a share of the trading fees generated by the swaps that occur in their pool. These fees are typically a small percentage of each transaction.
Additionally, many protocols offer governance tokens or other rewards, known as 'yield farming' incentives, to bootstrap liquidity. The total return must outweigh the risk of Impermanent Loss.
Glossar
Incentive Structure
Design ⎊ Incentive Structure defines the rules and economic rewards programmed into a protocol to encourage specific desired behaviors from users, such as providing liquidity, staking tokens, or participating in governance.
Incentive
Mechanism ⎊ Incentive structures within cryptocurrency, options trading, and financial derivatives function as engineered protocols to align the interests of diverse participants, influencing behavior and mitigating agency problems.