At the heart of decentralized finance (DeFi) lies a powerful innovation: Automated Market Makers (AMMs). These smart contract-based protocols have transformed how trading occurs on blockchain networks, eliminating the need for centralized order books and intermediaries. Instead, AMMs rely on liquidity pools to enable permissionless, always-on trading for users around the globe.
What Are AMMs and How Do They Work?
Automated Market Makers replace traditional exchange mechanics with algorithm-driven pricing. Instead of matching buyers and sellers, users trade directly against liquidity pools—smart contracts holding pairs of tokens. These pools use mathematical formulas, like the constant product formula (x * y = k), to determine token prices based on the current pool ratio.
Popular AMMs like Uniswap (Ethereum), Orca and Raydium (Solana), Osmosis (Cosmos), and zkSync-native protocols each implement their own variations of this core concept. They optimize for different use cases—whether it's stablecoin swaps, high-speed trading, multi-asset pools, or leveraging zero-knowledge proofs for scalability and privacy.
##Liquidity Pools and the Role of LPs
Liquidity pools are the lifeblood of AMMs. To function, they require token reserves, which are provided by users known as Liquidity Providers (LPs). By depositing equal values of two tokens into a pool, LPs enable trading and earn a share of the fees generated by swaps.
LPs take on market risk and are exposed to price movements and volatility within the pool. Still, providing liquidity can be a passive strategy to earn yield—especially when combined with other mechanisms like token incentives or staking rewards.
What Is Yield Farming?
Yield farming, or liquidity mining, builds on the AMM + LP foundation. It involves deploying capital across DeFi protocols to maximize returns. Strategies can range from simple LP token staking to complex multi-step maneuvers involving lending, borrowing, and cross-chain bridges.
Protocols often reward LPs with native tokens, effectively bootstrapping liquidity by incentivizing participation. This can lead to high yields—particularly in the early stages of a project—but also introduces added complexity and risk.
On chains like Solana and Cosmos, yield farming benefits from fast block times and low fees, enabling more granular strategy execution. zk-based platforms like zkSync and Starknet offer new frontiers for yield farming with improved security and privacy, although tooling and adoption are still maturing.
Examples of Yield Farming Strategies
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Stablecoin LP on Curve (Ethereum): Provide liquidity in a stablecoin pool like USDC/DAI/USDT. Earn trading fees and CRV token rewards, often boosted via veCRV staking.
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Raydium Fusion Pools (Solana): Deposit tokens like RAY/USDC into a Fusion Pool. Earn swap fees plus double incentives in RAY and a partner project's token.
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Osmosis Liquidity Mining (Cosmos): Provide liquidity to popular ATOM/OSMO pools. Stake LP tokens to earn OSMO emissions and governance rights.
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zkSync LP Incentives: Participate in early zkSync-era liquidity programs by adding assets to native AMMs. Earn protocol rewards and gain exposure to zk-native token launches.
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Lending-Looped Farming on Aave + Balancer (Polygon): Supply stablecoins on Aave, borrow another asset, loop it back into a Balancer pool, and earn multi-protocol rewards.
Interconnected Components of DeFi
AMMs, liquidity pools, and yield farming form a tightly integrated loop. AMMs need liquidity to operate. LPs provide that liquidity in exchange for yield. Yield farming supercharges that dynamic, creating incentives and feedback loops that drive user activity, capital flow, and protocol growth.
These mechanics now span across ecosystems—from EVM-compatible chains to high-throughput networks like Solana, interoperable hubs like Cosmos, and emerging zk-rollups—each contributing to the evolution and fragmentation of DeFi.
A Note on Risks
While the upside of DeFi participation can be attractive, it's important to understand that risks like impermanent loss, smart contract bugs, and rug pulls are very real.