Ethereum-based layer 2 perpetual exchange dYdX has seen amazing growth over the last few months - going from doing $10’s of millions of dollars in volume a day to now doing almost $10 billion a day - effectively eclipsing all centralized exchanges. Of course, much of this growth is being led by the liquidity mining program that the exchange has where traders can earn DYDX tokens - though I don’t view this as a negative - it’s just another “growth hack” that we’ve seen plenty of times before.
The crypto ecosystem has been experimenting with liquidity mining incentives for quite a while now with Synthetix pioneering it in early 2019 and Compound popularizing it in June 2020 (and subsequently kick-starting DeFi summer). Since then, there has been an explosion of these incentive programs across the base layer, layer 2’s, and the app layer. Of course, many of these schemes have “failed” as the projects liquidity mining program ended up putting too much downward pressure on the price of the token leading to a “death spiral”. In other words, the project ended up paying way too much of a customer acquisition cost (CAC) and ends up having a massive “debt” owed since they borrowed a lot of their future growth.
In saying that, I think that tokens coupled with a healthy liquidity mining program can do wonders for a projects initial growth. We’ve seen this play out across entire ecosystems such as the Polygon PoS chain (using MATIC rewards to drive initial growth) and we’ve seen it at the app-level throughout the successful DeFi summer era projects (Yearn, Curve, SushiSwap etc). Though of course, not all projects need their own liquidity mining programs to see growth as they can leverage off of other programs or their product is just that good that they don’t have to pay anything to get people to use it (Uniswap is the perfect example).
Tokens can also be excellent long-term community building tools when structured correctly. One of the best examples that I’ve seen of this has been the Index Coop which since the very beginning has had very modest liquidity mining programs, had no incentivized pool for the INDEX token (referred to as a “pool 2”) and focused on getting tokens into the hands of actual community members & contributors instead of pure speculators. This has led to a very healthy overall token distribution and a vibrant community - it also helps that the Index Coop’s products have found early product-market fit.
On that note, no amount of liquidity mining or token incentives can fix a fundamentally broken product. What ends up happening is that yield farming “locusts” basically farm the rewards, dump them into the open market, crush the price of the token, and then move onto the next yield farm because the actual product has no stickiness. The end result is that the core team and early community are left to pick up the pieces - trying to build and grow a product that is simultaneously paying down that “debt” that I mentioned earlier.
Finally, crypto projects aren’t the only ones that employ these kind of incentive programs. Banks will commonly offer “teaser rates” to attract new customers and then revert to the normal rate at some point in the future (hoping that a percentage of those new customers stick around). PayPal also famously greatly accelerated its growth by giving new users a free $10 sign up bonus (who doesn’t love free money?). And, earlier on in its life, Uber was able to offer cheap rides because it was being subsidized be venture capitalists - though these days Uber rides are around the same price (if not more expensive) than your standard taxi fare.
Charlie Munger’s famous quote - “show me the incentives and I'll show you the outcome” - has probably never applied so perfectly to an industry. At this point, it’s very clear what’s going to happen when a project in crypto spins up a liquidity mining program and those in the know/more experienced take full advantage of it (usually at the expense of the newer people). I don’t think this is “good” or “bad” - it’s just the way it is in the wild west that is the crypto ecosystem - the best thing you can do is just ensure that you don’t end up being exit liquidity for the whales.
Have a great day everyone,
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