The replacement of oil-based lubricants with water-based lubricants has been a desirable yet unrealised ambition in Tribology. The use of bio-lubricants has been previously explored; however limited advances have been achieved. Most work has focused on traditional mechanisms, with biomolecules being used to form friction reducing surface films. However, due to their chemical and physical instability, biomolecules are unsuited to long term applications. The alternative approach is to use stable, biofriendly molecules designed to exploit the lubrication mechanisms found in nature. Our investigation is inspired by synovial fluid lubrication mechanisms, resulting in a lubricant containing liposomal nanocapsules with an additive payload within their cores. A range of payloads were investigated, and a synthesis method was developed to allow for sufficient payload capture. Friction and wear performance were evaluated using a ball-on-flat reciprocating device and film thickness assessed using a transparent contact setup for in situ measurements, with hexadecane, water, and liposomes alone as a reference. These test methods provide an understanding of the underlying lubrication mechanisms of the water-based lubricants. In addition, further in-depth studies on the structures formed within the contact region and their mechanical properties were investigated through the use of atomic force microscopy techniques. The performance of encapsulated liposomal lubricants was found to be driven by the structures they form once ruptured within the contact region. The lubrication performance of these structures is shown to have a relationship with the structures’ charge, Young’s modulus, and adhesion energy properties. These properties can be varied through selection of the lipid, payload, and additional functionalisation. The conducted investigations provide a comprehensive understanding of the lubricating capability of encapsulated liposomes and how to improve them further. The findings of this work demonstrate the use of liposomes as a feasible avenue to create well-performing water-based lubricants for use in mechanical systems.